Fiscal policy in a Lucasian general equilibrium modelwith productive government spending

Abstract

This paper analyzes the effects of fiscal policy on the steady‐state growth rate of a two‐sectorialendogenous growth model. Our model deviates from the literature by focusing onthe linkage between government spending and financing policy due to the governmentbudget constraint, and the role of productive government expenditures on growth. It can beshown that the impacts of fiscal policies depend heavily on the allocation of governmentexpenditures. Long‐run growth is affected by macroeconomic policies only through governmentinvestments in human capital, but not through expenditures accelerating marketproduction. Therefore, an increase in human‐capital related government expendituresfinanced by higher lump‐sum taxation or income tax rate has a positive effect on the steady‐stategrowth rate. However, an increase in expenditures on government consumption andinfrastructure financed by a higher rate of income tax or/and lump‐sum taxation can substantiallyaffect steady‐state levels, but does not influence the fundamental growth rate ofthe economy.