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We show that a broad class of DSGE models with housing and collateralized borrowing predict a fall in house prices following positive government spending shocks. By contrast, we show that house prices in the US rise persistently after identified positive government spending shocks, using a structural vector autoregression methodology and accounting for anticipated effects. We clarify that the incorrect house price response is due to a general property of DSGE models—approximately constant shadow value of housing—and that modifying preferences and production structure does not help in obtaining the correct house price response. We then show that the effect on house prices is positive only when monetary policy strongly accommodates government spending shocks. The model, however, does not deliver a persistent rise in house prices. Properly accounting for the empirical evidence on government spending shocks and house prices using a DSGE model therefore remains a significant challenge.

ands. The time series analysis, covering the period 1953–1993, allows for different types of government spending. In general, spending is inspired by ideological and opportunistic motives: all government expenditure categories show an upward drift during election times and the partisan motives behind government spending are clearly revealed: left-wing cabinets attach greater importance to social security and health care than right-wing cabinets and right-wing cabinets value expenditure on infrastructure and defense more than left-wing parties. Constructive comments by Frans van Winden, Wilko Letterie, Peter Cornelisse, Arie Ros, André de Moor, Harry ter Rele and an anonymous referee are gratefully acknowledged.

Welfare ranking of policy instruments is addressed in a two-sector Ramsey model with monopoly pricing in one sector as the only distortion. When government spending is restricted, i.e. when a government is unable or unwilling to finance the required costs for implementing the optimum policy, subsidies that directly affect investment incentives may generate higher welfare effects than the direct instrument, which is a production subsidy. The driving mechanism is that an investment subsidy may be more cost effective than the direct instrument; and that the relative welfare gain from cost effectiveness can exceed the welfare loss from introducing new distortions. Moreover, it is found that the investment subsidy is gradually phased out of the welfare maximizing policy, which may be a policy combining the two subsidies, when the level of government spending is increased.

Altres ajuts: PRIN/2010J3LZEN003 ; By using the Survey of Professional Forecasters, we provide new evidence on the openeconomy effects of government spending, focusing on a well-known puzzle in the literature, that the real exchange rate depreciates in response to a fiscal expansion. Much of government spending is well anticipated over a one year horizon. Once news and surprise shocks are treated as different shocks, there is no depreciation puzzle for news shocks while it is still there for surprise shocks. Fiscal foresight seems to lie at the heart of the different exchange rate responses to news and surprise shocks, depending on the timing of the anticipated budget adjustment following the shock. Indeed, the results are broadly consistent with the prediction of a DSGE model with spending reversals.

In June the Coalition Government produced a budget that aimed to reduce the government deficit quickly. The plan was based mainly on cuts in current expenditure and reductions in transfers to individuals. There are four possible reasons for reducing the deficit, and all have been used to justify the policy. The first reason might be that the cost of borrowing is currently too high, and the second could be that if deficits persist the markets could lose confidence and the cost of borrowing would rise. The third reason might be that we have to reduce the debt stock in order that we prepare for the next crisis, whilst the fourth, and perhaps most persuasive in the long run, is that it is unfair to borrow so much and therefore reduce the consumption of future generations. If either of the first two had merit there would be a case for swift consolidation, whilst if the third or fourth predominate, we should not be in any rush to act until output is nearer full capacity.

U.S.-Economic conditions