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Recent evidence on the effect of government spending shocks on consumption cannot be easily reconciled with existing optimizing business cycle models. We extend the standard New Keynesian model to allow for the presence of rule-of-thumb (non-Ricardian) consumers. We show how the interaction of thelatterwithstickypricesanddeficit financing can account for the existing evidence on the effects of government spending. JEL Classification: E32, E62
Galı́ et al. (2007) studied this question.
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