Frictional product market, supply chains and the impact of government expenditures on private consumption

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Standard macroeconomic models predict positive values of the government spending multiplier and a decreasing relationship between private consumption and government expenditures. The latter result is at odds with empirical evidence, suggesting that this negative pattern is either moderate or insignificant. Moreover, there are works indicating that this relationship is positive. The aim of this paper is to rationalize positive reactions of both output and consumption induced by higher government spending. To explain those patterns, I use a theoretical model including two ingredients: search frictions in the product market and simple supply chains. It is shown that, in isolation, these two elements give rise to the standard prediction found in the theoretical literature: an increase in fiscal expenditures crowds out private consumption. However, the interaction of both elements generates two equilibria and one of them features both a positive fiscal multiplier and an increasing relationship between government spending and private consumption.