Quantitative Economics: Nov, 2013, Volume 4, Issue 3
Public consumption over the business cycle
Rüdiger Bachmann, Jinhui H. Bai
What fraction of the business cycle volatility of government purchases is ac-
counted for as endogenous reactions to overall macroeconomic conditions? We
answer this question in the framework of a neoclassical representative household
model where the provision of a public consumption good is decided upon en-
dogenously and in a time-consistent fashion. A simple version of such a model
with aggregate productivity as the sole driving force fails to match important fea-
tures of the business cycle dynamics of public consumption, which comes out as
not as volatile and persistent as in the data and too synchronized with the cycle.
We add implementation lags and implementation costs in the budgeting process
to the model, plus taste shocks for public consumption relative to private con-
sumption, and achieve a better fit to the data. All these ingredients are essential
to improve the fit. In our baseline specification 50% of the variance of public con-
sumption is driven by aggregate productivity shocks.
Keywords. Public consumption, aggregate productivity shocks, business cycles,
implementation lags, implementation costs, taste shocks, time-consistent public
JEL classification. E30, E32, E60, E62, H30.