Two Essays on Macro Economic Implications for Government Spending Effects

Abstract

My dissertation comprises two chapters. The first chapter is an empirical study of government spending effects in both developed and developing countries. Based on the panel structural VAR analysis and the sign-restriction method for identifying the government spending shock, I find that private consumption increases in response to a positive government spending shock in both groups, yet such consumption effect is greater in developing than industrial countries; the response of real effective exchange rate to the government spending shock varies across groups: it depreciates in developed countries and appreciates in developing countries.

The second chapter investigates the transmission mechanism underlying the empirical findings of the first chapter. I set up a New Keynesian small open economy model, augmented with hand-to-mouth consumers, non-separable preferences between public and private consumptions, and government spending reversals to well replicate the responses of private consumption and the real exchange rate in the first chapter. The large fraction of hand-to-mouth consumers and high complementarity between public and private consumption contribute to the greater positive response of private consumption in developing countries; when introducing spending reversals to the model in the context of developed countries, it magnifies the positive response of private consumption by mitigating the negative wealth effect resulting from a fiscal expansion, moreover, it induces the real exchange rate to become depreciated after several quarters.