Norges Bank

Working Paper

Government spending shocks and rule-of-thumb consumers: The role of steady state inequality

By Gisle James Natvik
Working Paper

Galí, López-Salido, and Vallés (2007) suggest that because part of the population follow a rule-of-thumb by which they spend their entire disposable income each period, private consumption responds positively to defcitfinanced increases in government spending. Key to this result is a centralized labor market. I show that the ability to explain the positive consumption response as a consequence of rule-of-thumb behavior hinges on the arbitrary assumption that wealth is redistributed across households in steady state. Inequality leads to equilibrium indeterminacy and undermines the theoretical foundation of the centralized labor market.

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ISSN 1502-8143 (online)

Published 18 August 2010 12:00
Published 18 August 2010 12:00