Assessing the Impact of a Change in the Composition of Public Spending: A DSGE Approach, Issues 2007-2168Despite intense calls for safeguarding public investment in Europe, public investment expenditure, when measured in relation to GDP, has steadily fallen in the last three decades, evoking fears that economic activity may be correspondingly negatively affected. At the same time, however, public consumption in the EU-12 countries has trended up. In this paper, we provide a macroeconomic assessment of the observed change in the composition of public spending in the euro area in a medium-scale two-country dynamic stochastic general equilibrium (DSGE) model. First, we identify the channels through which both temporary and permanent public investment shocks generate larger fiscal multipliers than exogenous increases in public consumption. Second, we quantify the negative impact of a change in fiscal stance, characterized by a permanent rise in public consumption and a permanent fall in public investment, keeping the overall level of public spending constant. The key message of the paper is that calls for reversing the observed trend in the composition of public spending are well justified. |
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20 Long-run Public aggregate demand Bocconi University budget constraint bundles calibration Coenen composition of public consumption and public differentiated intermediate differentiated labour services differentiated output domestic and foreign DSGE dynamic responses effects of public elasticity of substitution EU-12 countries euro area European Commission firm ƒ first-order condition fiscal authority foreign intermediate government spending household members household-specific impact impulse response increase in public inflation intermediate-good firms internationally traded bonds intertemporal intratemporal elasticity labor supply Lagrange multiplier Long-run Public Consumption Luxembourg macroeconomic marginal cost markup members of household money-to-consumption ratios monopolistically competitive monopolistically competitive markets NAWM negative wealth effect Nf.t non-tradable final parameters Pc.t percent of GDP percentage point permanent Perotti PH.t private consumption private investment Public Consumption Multiplier Public Consumption Shock Public Investment Multiplier public investment shock public spending real wages RK.t shadow price Straub tax wedge terms of trade types of households wage contracts