News About Government Spending And The Business Cycles:Theory And Empirics

In recent years,the Central Economic Working Conference has repeatedly emphasized the importance of expectations in macroeconomics and macro-control.The Central Economic Working Conference clearly proposed that "we must accurately grasp the degree of macro-control,proactively pre-adjust and fine-tune,and strengthen policy synergy;we must respond to social concerns in a timely manner,and actively guide market expectations in a targeted manner" in 2019,and stabilizing expectations is one of the general requirements for economic work.In the 2021,the Central Economic Working Conference,it was further emphasized that "the current economy is facing the triple pressure of demand contraction,supply shock and weakening expectations",recognizing the importance of stabilizing expectations and requiring continuous enhancement of the scientificity,foresight and proactiveness of macroeconomic regulation and control.The central economic work deployment fully reflects the deepening of our Party’s understanding of the laws of China’s macroeconomic development under the new situation.Classical macroeconomic theory holds that rational people behave in a forward-looking manner and will adjust their current behavior according to the future information obtained.Under the assumption of rational expectations,the effect of fiscal policy implementation will be fully foreseen by rational agents and they will react in advance,and this phenomenon is called fiscal foresight or news shock.However,the above phenomenon has not received sufficient attention,and there is a lack of empirical evidence to test the effects of government spending news shocks on macroeconomic fluctuations,as well as a lack of sufficient arguments on the transmission mechanism of government spending news shocks based on theoretical perspectives.Therefore,it is important to investigate the impact of government spending news shocks on macroeconomics from both theoretical and empirical perspectives at the academic research and policy making levels.We develop the analysis at three levels:empirical evidence,underlying theory,and model fitting.In terms of empirical evidence,we identify the impact of government spending news shocks on main macroeconomic variables in the current period using a Bayesian vector autoregressive model based on the maximum forecast error variance method using data on government spending news shock in the United States.It is found that when economic agents capture news of future government spending expansion,current output,consumption,investment,and hours worked respond positively in advance,with positive co-movement among the main macro variables,bringing about a business cycle driven by government spending expectations.This is another favorable evidence of the effectiveness of government fiscal policy given at the empirical level using the latest research methodology.In terms of underlying theory and model fitting,the paper examines the transmission mechanisms that generate expectations-driven business cycles.It is important to emphasize that traditional macroeconomic models,represented by the real business cycle(RBC)model,are unable to explain this co-movement among the main economic variables.This inconsistency between empirical and theoretical results is known as the "government spending news puzzle".If this puzzle cannot be resolved in the theoretical model,the effect of government spending will be underestimated when assessing the effect of fiscal policy using the DSGE model.We modifiy the traditional macroeconomic model to resolve the "government spending news puzzle".Firstly,macroeconomics suggests that personal satisfaction comes not only from individual consumption and leisure levels,but also from the satisfaction derived from comparing oneself with others.In order to obtain this satisfaction,individuals will increase their hours worked,which is known as the KUJ effect in the literature.We incorporate this psychological factor into the standard RBC model,effectively resolving the "government spending news shock".By inducing contemporaneous complementarities between consumption and hours worked,and intertemporal complementarities between consumption and investment,the KUJ effect can reduce the negative income effect of government spending,thus bringing about"co-movement" among macroeconomic variables.In the quantitative analysis,the quantitative model constructed in this paper is able to fit the post-World War II U.S.business cycle data well.In the second model,we address the co-movement puzzle in terms of government spending externalities.In mainstream macroeconomics,government spending externalities have become one of the important ways in which government spending affects the macroeconomy.We theoretically demonstrate that considering government spending utility externalities and production externalities alone is unlikely to generate an expectations-driven business cycle.However,if both investment adjustment costs and capacity utilization are included in the RBC model,the synergy between the three is necessary to generate an expectation-driven economic cycle of government spending.The government spending externality enhances the income effect of economic agents,which has the effect of crowding out current consumption.The other two elements enhance the substitution effect,which reduces the negative effect of the income effect on hours worked and significantly increases the hours worked of economic agents,thus generating a co-movement of consumption and hours worked.Finally,to further clarify the channels and transmission mechanisms through which government spending news shocks play a role in the standard RBC model,we use a general framework to demonstrate the conditions necessary to resolve the"government spending news puzzle" in the RBC model,namely 1)unanticipated government spending can crowd in consumption,2)consumption and hours worked exhibit co-movement.We discusses five representative theoretical models and constructs three types of social externalities models with different transmission mechanisms based on labor market differences:consumption externalities,labor externalities,and production externalities.In summary,we use a state-of-the-art approach to present new evidence from the empirical level that active fiscal policy can work,and to investigate the transmission mechanism of government spending news shocks in macroeconomic models at the theoretical level by introducing factors of individual consumer behavior or government spending externalities into the standard RBC model at the quantitative level,the model constructed in this paper can be easily extended to medium-scale DSGE models,providing a benchmark model for properly assessing the importance of government spending news in the business cycle.