Content area
Full Text
Macroeconomic Dynamics, 16 (Supplement 1), 2012, 149166. Printed in the United States of America. doi:10.1017/S1365100511000575
ROGER E. A. FARMER AND DMITRY PLOTNIKOV
University of California, Los Angeles
This paper uses the old Keynesian representative agent model developed by Roger E. A. Farmer [Expectations, Employment and Prices. New York: Oxford University Press (2010)] to answer two questions: (1) Do increased government purchases crowd out private consumption? (2) Do increased government purchases reduce unemployment? Farmer compared permanent tax-nanced expenditure paths and showed that the answer to (1) was yes and the answer to (2) was no. We generalize his result to temporary bond-nanced paths of government purchases that are similar to the actual path that occurred during WWII. We nd that a temporary increase in government purchases does crowd out private consumption expenditure as in Farmer. However, in contrast to Farmers experiment, we nd that a temporary increase in government purchases can also reduce unemployment.
Keywords: Unemployment, Fiscal Policy, Crowding Out
1. INTRODUCTION
Economists are still debating the causes of the Great Depression eighty years later.1 For thirty years after the publication of The General Theory of Employment, Interest, and Money [Keynes (1936)], the dominant theory attributed the Depression to a lack of aggregate demand. Most contemporary interpretations of Keynes are based on the idea that unemployment occurs because prices and wages adjust slowly in response to monetary shocks [Clarida et al. (1999); Woodford (2003); Gal (2008)]. In a series of books and papers, Farmer (2008a; 2008b; 2009; 2010b; 2010c; 2010d) develops an alternative interpretation of Keynesian economics that does not rely on sticky prices. In (2010b) he raises the possibility, in a representative agent model with Keynesian unemployment, that a permanent increase in government expenditure will be ineffective at restoring full employment.
Farmers paper (2010d) compared two steady state policies within the context of the old-Keynesian model. In that model, condence is an independent driving variable that determines the amount that households are willing to pay for assets.
We wish to thank the National Science Foundation for funding this research under Grant 0720839. We would also like to thank a referee of this journal for his/her helpful comments. The title of the paper is borrowed from Blinder and Solow (1973), who asked the same question...