Can Public Spending Boost Private Consumption?

Abstract

This paper analyses the effects on private consumption from an increase in productive and unproductive public spending. A new-Keynesian model incorporating price and wage rigidities, monetary policy and various fiscal rules is developed and estimated, using Bayesian techniques, to capture the key cyclical characteristics of the US economy. We find that price and wage rigidities along with a positive shock to the part of public spending that is productive are sufficient to boost private consumption. Moreover, we show that this initial positive reaction of private consumption is sufficient to create a positive present value consumption multiplier for more than five years. Finally, we show that our main results remain robust to changes in the monetary rule and the various methods of deficit financing.