Government Spending and Capital Accumulation

This paper extends S. Djajic (1987) to allow for an endogenous rate of time preference, and reexamines Djajic's experiment: how the optimal rates of private consumption and capital accumulation will respond to an unanticipated temporary expansion in government spending. The key factors determining the adjustment patterns are the difference between the marginal utility of private consumption and that of public spending, the timing of policy reversion, and the relationship between private and public consumption in household utility. If private and public consumption are Edgeworth independent, whether investment increases with the length of fiscal expansion depends on whether the marginal utility of private consumption exceeds that of public consumption.