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Understanding the effects of government spending in a time-inconsistent model

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  • Choi, Yoonseok
  • Kim, Sunghyun Henry

Abstract

This paper examines the effects of government spending shock in a model that features time inconsistency. We build a time-inconsistency edifice on a standard dynamic stochastic general equilibrium (DSGE) model to explore dynamic behavior of macroeconomic aggregates and present-value multipliers. Comparison of the results from a time-inconsistent model (TIM) and a time-consistent model (TCM) reveals that two models deliver markedly different dynamic responses and multiplier effects. A positive government spending shock in TIM delivers a larger decrease in consumption, a smaller decrease in investment and a larger increase in labor and output than TCM. Impact and long-run fiscal multipliers for output in TIM are around 0.28 and 0.01, respectively, which are larger than those in TCM (0.13 and −0.23). The larger multipliers result from the sophistication effect formed by an individual’s perception of their future selves’ behavior. Various sensitivity analyses on important parameters do not reverse the baseline result.

Suggested Citation

  • Choi, Yoonseok & Kim, Sunghyun Henry, 2021. "Understanding the effects of government spending in a time-inconsistent model," Economic Modelling, Elsevier, vol. 98(C), pages 266-279.
    • Handle: RePEc:eee:ecmode:v:98:y:2021:i:c:p:266-279
    DOI: 10.1016/j.econmod.2020.11.018
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    More about this item

    Keywords

    Government spending; Present-value multipliers; Government spending rule; Time-inconsistent preference; Sophistication effect;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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