Fiscal Spending Shocks, Endogenous Government Spending, and Real Business Cycles

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We analyze a real business cycle model in which the government optimally chooses public investment and nonmilitary current expenditures, to maximize the welfare of the representative private agent. We characterize the optimal response of endogenous spending to shocks to technology and to military expenditures. Comovements between the components of government spending and other macroeconomic aggregates predicted by the model are compared with the corresponding comovements in the U.S. data. The model captures the qualitative features of the relative volatilities of the components of government spending quite well, but predicts too high correlations between the components of government spending and output.

Published in: Journal of Economic Dynamics and Control (Vol. 20, No. 1-3, January-March 1996, pp. 237-256) https://doi.org/10.1016/0165-1889(94)00850-X.