Fiscal Policy in General Equilibrium

Abstract

This paper studies the effects of fiscal policy within a quantitative general equilibrium model. We find that the basic neoclassical model has important dynamic interactions of capital and labor in response to policy disturbances, and that these interactions alter standard neoclassical predictions about the equilibrium effects of fiscal policy. Our main findings are that (i) there is likely to be a long run multiplier associated with changes in government purchases, (ii) permanent changes in government purchases induce larger effects than temporary changes, (iii) the financing decision associated with changes in government purchases is quantitatively much more important than the direct resource cost of changes in government purchases, and (iv) public investment policies have dramatic effects on output and on private investment.