Abstract
According to empirical evidence, expansionary government spending policies increase consumption and the number of active firms in an economy and have large positive international spillover effects. Using a two-country sticky-price model with a variable number of producers, we analyze movements in output, consumption, extensive-margin investment and foreign output in response to government spending expansions. Our baseline results show that, first, there is divergence between consumption and firm entry; and second, spillovers are generally small. A large share of imports in government spending or a high trade elasticity can generate large spillovers in the model, but do not induce consumption-investment comovement. We propose useful government spending as a device to induce both large spillovers and positive consumption-investment comovement.
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