Public Consumption Over the Business Cycle

Working Paper: NBER ID: w17230

Authors: Ruediger Bachmann; Jinhui Bai

Abstract: What fraction of the business cycle volatility of government purchases is accounted for as endogenous reactions to overall macroeconomic conditions? We answer this question in the framework of a neoclassical representative household model where the provision of a public consumption good is decided upon endogenously and in a time-consistent fashion. A simple frictionless version of such a model with aggregate productivity as the sole driving force can explain almost all the volatility of U.S. non-defense government consumption expenditures. However, such a model fails to match other important features of the business cycle dynamics of public consumption, which comes out as not persistent enough and too synchronized with the cycle. We add implementation lags and implementation costs in the budgeting process to the model, plus taste shocks for public consumption relative to private consumption, and achieve a substantially better match to the data. All these ingredients are essential to improve the fit. Depending on the precise specification of the flow utility function over private consumption, public consumption and leisure, 25-40 percent of the variance of public consumption is driven by aggregate productivity shocks.

Keywords: public consumption; business cycle; government purchases; macroeconomic conditions

JEL Codes: E30; E32; E60; E62; H30

Causal Claims

Cause	Effect
aggregate productivity shocks (O49)	public consumption (H49)
implementation costs (J32)	public consumption (H49)
implementation lags (J68)	public consumption volatility (E20)
taste shocks for public consumption relative to private consumption (D11)	public consumption dynamics (D16)
aggregate productivity shocks (O49)	public consumption volatility (E20)
endogenous reactions to macroeconomic conditions (E32)	fluctuations in public consumption (E20)