FRB: Understanding the Effects of Government Spending on Consumption

International Finance Discussion Papers

Understanding the Effects of Government Spending on Consumption
Jordi Gali; J. David Lopez-Salido; Javier Valles
2004-805 (April 2004)

Abstract: Recent evidence on the effect of government spending shocks on consumption cannot be easily reconciled with existing optimizing business cycle models. We extend the standard New Keynesian model to allow for the presence of rule-of-thumb (non-Ricardian) consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.

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Keywords
rule-of-thumb consumers, fiscal multiplier, government spending, Taylor rules

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