MILITARY SPENDING AND THE GROWTH‐MAXIMIZING ALLOCATION OF PUBLIC CAPITAL: A CROSS‐COUNTRY EMPIRICAL ANALYSIS

In this paper we present an endogenous growth model to analyze the growth maximizing allocation of public investment among N different types of public capital. Using this general model of public capital formation, we analyze the stability of the long‐run equilibrium and we derive the growth‐maximizing values of the shares of public investment allocated to the different types of public capital, as well as the growth‐maximizing tax rate (amount of total public investment as a share of GDP). Then we proceed with an empirical investigation of the theoretical implication of the model that both the effects of the shares of public investment and the tax rate on the long‐run growth rate are non‐linear, following an inverse U‐shaped pattern. Using data of public investment in infrastructure and military capital formation, we derive empirical estimations that confirm the theoretical implications of the model. (JEL E62, H56, O40).     

Time-Series Evidence on the Nonlinearity Hypothesis for Public Spending

Barro-type endogenous growth models propose a nonmonotonic relationship between productive public spending and growth. Under this so-called nonlinearity hypothesis the size and direction of growth effects due to an increase in public spending depend on the share of public spending in GDP. Employing German time-series data we examine the validity of the nonlinearity hypothesis. We estimate growth effects by using models whose coefficients are allowed to vary with the share of public spending in GDP. Our results support the hypothesis for public consumption but not for public investment data. (JEL H54 , E62 , C22 )     

HEALTH CARE INFLATION AND ITS IMPLICATIONS FOR MONETARY POLICY

Motivated by recent findings on the cyclical movement of both health and health spending, we construct a general equilibrium model that distinguishes health care demand from the demand for other goods. Using this model, we are able to generate inflation dynamics and cyclicality of health that match the US data. When the model is subjected to an expansionary monetary policy shock, it yields different output and inflation responses compared with a two‐sector model with homogeneous demand. We show that the trade‐off between leisure and health spending plays an important role in model dynamics. The model further predicts different degrees of inflation stabilization across sectors when a shift in the monetary policy occurs. (JEL E52, E31, E32, I10)     

LIMITED ASSET MARKET PARTICIPATION AND THE EURO AREA CRISIS: AN EMPIRICAL DSGE MODEL

We estimate a medium‐scale dynamic stochastic general equilibrium model for the Euro area with limited asset market participation (LAMP). Our results suggest that in the recent European Monetary Union years LAMP is particularly sizable (39% during 1993–2012) and important to understand business cycle features. The Bayes factor and the forecasting performance show that the LAMP model is preferred to its representative household counterpart. In the representative agent model the risk premium shock is the main driver of output volatility in order to match consumption correlation with output. In the LAMP model this role is played by the investment‐specific shock, because non‐Ricardian households introduce a Keynesian multiplier effect and raise the correlation between consumption and investments. We also detect the contractionary role of monetary policy shocks during the post‐2007 years. In this period consumption of non‐Ricardian households fell dramatically, but this outcome might have been avoided by a more aggressive policy stance. (JEL C11, C13, C32, E21, E32, E37)     

THE COLLAPSE AND RECOVERY OF THE CAPITAL SHARE IN EAST GERMANY AFTER 1989

After the 1990 unification, East Germany's capital income share plunged to 15.2% in 1991, then increased to 37.4% by 2015. To account for these large changes in the capital share, I model an economy that gains access to a higher productivity technology embodied in new plants. As existing low productivity plants decrease production, the capital share varies due to the nonconvex production technology: plants require a minimum amount of labor to produce output. Two policies—transfers and government‐mandated wage increases—have opposite effects on output growth, but contribute to lowering the capital share early in the transition. (JEL E20, E25, O11)     

NONLINEARITIES AND THE SUSTAINABILITY OF THE GOVERNMENT'S INTERTEMPORAL BUDGET CONSTRAINT

We analyze the sustainability of the government's intertemporal budget constraint and the corresponding fiscal reaction function within a nonlinear error‐correction framework. Our empirical analysis, based on Italy, provides some evidence that the Italian government is meeting its intertemporal budget constraint. Nevertheless, we show that the burden of correcting budgetary disequilibria is entirely carried out by changes in the average tax rate, with a weakly exogenous government spending, possibly determined by the political process. We also document some rigidities of the tax instrument, in terms of downward inflexibility of the average tax rate with respect to its long‐run level. Finally, we provide some evidence in favor of a nonlinear adjustment toward a sustainable long‐run equilibrium, as the average tax rate adjusts faster the further away it gets from the equilibrium. By considering the behavior of taxes across the economic cycle, we also provide some evidence of inflexibility of the tax instrument during bad times. (JEL C32, C51, C52, H20, H50)     

CONSUMPTION EXTERNALITIES AND MONETARY POLICY WITH LIMITED ASSET MARKET PARTICIPATION

This article explores the interaction between consumption externalities and limited asset market participation (LAMP) in the standard New‐Keynesian model. We assess the performance of simple Taylor‐type interest rate rules with respect to (a) equilibrium determinacy, (b) the model's ability to simultaneously generate output and inflation volatility similar to the pre‐Volcker era, and (c) the model's response to a technology shock. We find that when individual preferences are affected by average household consumption (Aggregate Consumption Externality), stronger externalities increase the range of LAMP for which multiple equilibria arise even if the policy rule satisfies the Taylor principle. The interaction of LAMP and externalities can generate vast inflation/output relative volatility in line with the one observed in the data in the 1970s. According to our analysis, consumption externalities also affect the responses of endogenous variables to total factor productivity shocks. (JEL E4, E5)     

THE U.S. LABOR INCOME SHARE AND AUTOMATION SHOCKS

The causes and consequences of the 1964–2016 swings in the U.S. labor income share/labor share (LS) are parsed through the lens of a structural model estimated on aggregate and LS series jointly. Where conventional models fall short, the present model yields a counter-cyclical LS unconditionally and in response to demand and monetary policy shocks, as well as a small wage pro-cyclicality, via moderate wage indexation. Shifts in automation, workers' market power, investment efficiency, and the relative price of investment account for 54%, 24%, 6%, and 4% of LS fluctuations, respectively. Automation shocks explain the lion's share of the post-2007 cyclical LS tumble and 11% of output cycles, and generate a distinctive counter-cyclical labor response. (JEL E32, E25, E52)     

GOVERNMENT DEBT‐THRESHOLD CONTRACTS

Politicians tend to push the amount of public debt beyond socially desirable levels in order to increase their reelection chances. We develop a model that provides a new explanation for this behavior: office holders undertake debt‐financed public projects, but postpone the timing of part of the output to the next term. This makes it difficult to replace them. As a consequence, the office holders' reelection chances rise—as does public debt. As a potential remedy for this inefficiency, we allow candidates for public office to offer government debt‐threshold contracts. Such a contract contains an upper limit for government debt and the sanction that an office holder violating this limit cannot stand for reelection. We show that such competitively offered contracts contain low debt levels that limit debt financing and improve the citizens' welfare. When negative macroeconomic events occur, government debt‐threshold contracts may be violated, and the economy is stabilized. (JEL: D7, D82, H4)     

PUBLIC SPENDING REALLOCATIONS AND ECONOMIC GROWTH ACROSS DIFFERENT INCOME LEVELS

This article examines the effects of public spending reallocations on economic growth. Assembling a disaggregated public spending dataset of 83 countries over the 1970–2011 period, we show that spending reallocations toward education, from health and social protection, have significant growth‐promoting effects across a wide range of countries' income levels. However, income heterogeneity matters, particularly when reallocations involve infrastructure spending. Specifically, a reallocation from this spending to education also promotes growth, albeit primarily when a country's income level is low. This occurs because the effects of infrastructure spending are particularly weak in low‐income countries, possibly due to the low quality of governance. (JEL O43, H50, O11)     

ACCOUNTING FOR THE CYCLICAL DYNAMICS OF INCOME SHARES

Over the business cycle, labor's share of output is negatively but weakly correlated with output, and it lags output by about four quarters. Profits' share is strongly pro‐cyclical. It neither leads nor lags output, and its volatility is about five times that of output. Those assumptions relate to the structure of aggregate technology and the degree of competition in factor markets. Despite much evidence in favor of time‐varying income shares, macroeconomics still lacks models that can account for their time series facts. This article constructs a model that can replicate those facts. We introduce costly entry of firms in a model with frictional labor markets and find a link between the ability of the model to replicate income shares' dynamics and the ability of the model to amplify and propagate shocks. That link is a weak correlation between the real interest rate and output, a fact in U.S. data but a feature that models of aggregate fluctuations have had difficulty achieving. (JEL E3, E25, J3, E24)     

LABOR'S SHARE,THE FIRM'S MARKET POWER,AND TOTAL FACTOR PRODUCTIVITY

We investigate the relationship between labor's share, firm's market power, and the elasticity of output with respect to labor input using an approach based on an unobserved components model. The approach yields time‐varying estimates of market power and the elasticity. Evidence on the market power of firms (which we find to be rising since 2000) gives a deeper understanding of movements in labor's share and the labor wedge. The generated values of the elasticity yield revised estimates of total factor productivity growth which is informative about the extent of the downward bias inherent in traditional estimates which use labor's share as a proxy for the elasticity. (JEL O47, C32, E25)     

WHAT DO BRITISH HISTORICAL DATA TELL US ABOUT GOVERNMENT SPENDING MULTIPLIERS?

British data from the early 1700s through World War I reflect the results of numerous high‐quality natural experiments of government spending. Britain frequently participated in wars, increasing military spending massively. Wartime distortions were relatively limited because the government generally adopted tax smoothing policy and rarely implemented interventions. Government spending multiplier estimates are low or negative and significantly below unity. This paper finds no evidence that the multiplier was higher in the slack state than in the normal state. (JEL E32, E62)     

WOMEN PREFER LARGER GOVERNMENTS: GROWTH,STRUCTURAL TRANSFORMATION,AND GOVERNMENT SIZE

The increase in income per capita is accompanied, in virtually all countries, by two changes in economic structure: the increase in the share of government spending in gross domestic product (GDP), and the increase in female labor force participation. We argue that these two changes are causally related. We develop a growth model based on Galor and Weil (1996) where female participation in market activities, fertility, and government size, in addition to consumption and saving, is endogenously determined. Rising incomes lead to a rise in female labor force participation as the opportunity cost of staying at home and caring for the children increases. In our model, higher government spending decreases the cost of performing household chores, including, but not limited to, child rearing and child care, as in Rosen (1996) . We also use a wide cross‐section of data for developed and developing countries and show that higher market participation by women is positively and robustly associated with government size. We then investigate the causal link between participation and government size using a novel unique data set that allows the use of the relative price of productive home appliances as an instrumental variable. We find strong evidence of a causal link between female market participation and government size. This effect is robust to the country sample, time period, and a set of controls in the spirit of Rodrik (1998) . (JEL O4, E62, H11)     

QUASI‐EXPERIMENTAL ANALYSIS ON THE EFFECTS OF ADOPTION OF A VALUE ADDED TAX

Value added taxes (VATs) have become an important source of government funding in past decades, but little empirical work has been carried out on their macroeconomic impacts. As the decision to implement a VAT is endogenous, regression methods analyzing the impact of the policy choice will yield biased estimates. To solve this problem, I first model the VAT adoption decision for 192 countries using survival analysis. I then match adopters to non‐adopters using propensity score matching. I find that VAT adoption is associated with an increase in growth and investment as well as lower inflation and government spending as a share of GDP. (JEL H20, H21)     

FISCAL POLICY AND LENDING RELATIONSHIPS

This paper studies how fiscal policy affects loan market conditions in the United States. First, it conducts a structural vector‐autoregression analysis showing that the bank spread responds negatively to an expansionary government spending shock, while lending increases. Second, it illustrates that these results are mimicked by a dynamic stochastic general equilibrium model where the bank spread is endogenized via the inclusion of a banking sector exploiting lending relationships. Third, it shows that lending relationships represent a friction that generates a financial accelerator effect in the transmission of the fiscal shock. (JEL E44, E62)     

ENTRY AND EXIT,PRODUCT VARIETY,AND THE BUSINESS CYCLE

We study the stochastic behavior of a dynamic general equilibrium model with monopolistic competition. Each seller sells his product in the consumption goods as well as the investment goods market and has market power in both. Consumers derive utility from a constant elasticity of substitution (CES) aggregate of all the consumption goods and augment their capital stock by a CES aggregate of all the investment goods. We analyze the equilibrium of this economy allowing for an endogenous determination of the number of firms and therefore of products. The principal effect we wish to highlight is the endogenous propagation and magnification of technology and preference disturbances through product space variations. (JEL E32, D43, L16)     

THE IMPACT OF FISCAL POLICY ON PROFITS

This paper investigates the impact of fiscal policy on profits using panel data for 18 high‐income OECD countries during the period 1975–1999. We estimate a profit equation allowing a consistent treatment of the government budget constraint, and we try to disentangle the effects of different spending and taxation items. As far as public spending is concerned, our results strongly suggest that capital expenditures are associated with higher profits, while expenditures on goods and services and in particular on wages and salaries deteriorate profits. In general, “productive” expenditures seem to increase profits while the effect of “unproductive” expenditures is insignificant. Transport and communication expenditures seem to have a positive impact on profits. On the revenue side, we find that both direct and indirect taxation has a negative impact on profits. (JEL E62, H32, H54)     

ON ENDOGENOUS BUSINESS CYCLES UNDER INCREASING RETURNS TO VARIETY AND SECTOR‐SPECIFIC EXTERNALITY

We examine the theoretical as well as quantitative interrelations between endogenous business cycles, increasing returns to product variety and sector‐specific productive externalities within a two‐sector real business cycle model. In a calibrated version of our benchmark closed‐economy setting, the threshold level of investment externalities needed for equilibrium indeterminacy is found to be monotonically increasing in the degree of market competitiveness. We also study the model's local stability properties (i) when the parameters that govern the level of intermediate‐good producers' market power and the strength of variety effects are disentangled; and (ii) in the context of a small open economy. (JEL E30, E32, O41)     

MONETARY POLICY AND ENDOWMENT RISK IN A LIMITED PARTICIPATION MODEL

A limited participation model is constructed to study the risk‐sharing role of monetary policy. A fraction of households exchange money for interest‐bearing government nominal bonds in the asset market and the government injects money through open market operations. In equilibrium, money is nonneutral and monetary policy redistributes consumption across households. Without idiosyncratic endowment risk, monetary policy becomes a perfect risk‐sharing tool, but with idiosyncratic endowment risk, it is not. The Friedman rule is not optimal in general. (JEL E4, E5)