Sectoral Composition of Government Spending and Macroeconomic (In)stability

This paper examines the quantitative interrelations between sectoral composition of public spending and equilibrium (in)determinacy in a two-sector real business cycle model with positive productive externalities in investment. When government purchases of con- sumption and investment goods are set as constant fractions of their respective sectoral output, we show that the public-consumption share plays no role in the modeliÌs local dynamics, and that a su¢ ciently high public-investment share can stabilize the economy against endogenous belief-driven cyclical aÌuctuations. When each type of government spending is postulated as a constant proportion of the economyiÌs total output, we Önd that there exists a trade-o§ between public consumption versus investment expenditures to yield saddle-path stability and equilibrium uniqueness.