The Timing of Government Spending in a Dynamic Model of Imperfect Competition

Xavier X. Sala-i-Martin

Yale Economic Growth Center Discussion Paper #641, August 1991.


The debate on macroeconomic implications of fiscal policy has focused on the question of whether the timing of taxes matters but has neglected the study of the relevance of the timing of public spending. This paper tries to fill that hole by presenting a model of dynamic fiscal policy where firms behave non competitively and households have finite horizons. I show that the existence of monopoly rents makes the timing of future government spending relevant. In particular I show that, contrary to the prediction of most other models of fiscal policy, an anticipated increase in public spending financed by subsequent tax increases may have expansionary effects as the positive wealth effect associated with monopoly rents outweights the negative wealth effect of anticipated higher taxes. I also show that if the public spending expansion is financed by subsequent public spending contraction, the experiment has unambiguous expansionary effects. The model presented can be thought as a microfounded story of Blanchard's Good-News-Bad-News model of public policy.


Macroeconomic Aspects of Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation, E620. Fiscal Policies and Behavior of Economic Agents: Household, H310. Fiscal Policies and Behavior of Economic Agents: Firm, H320. Taxation and Subsidies: Efficiency; Optimal Taxation , H210. Microeconomic Theory--Theory of the Household (Consumer Demand), 0222. Microeconomics--Theory of Production, 0223. Fiscal Theory; Empirical Studies Illustrating Fiscal Theory, 3212.