Non-Ricardian Households and Fiscal Policy in an Estimated DSGE Model of the Euro Area

Abstract

In this paper, we revisit the effects of government spending shocks on private aggregate consumption within an estimated New-Keynesian DSGE model of the euro area featuring non-Ricardian households and a relatively detailed fiscal policy set up. Employing Bayesian inference methods, we show that the presence of non-Ricardian households is in general conducive to raising the level of aggregate consumption in response to government spending shocks when compared with the benchmark specification without non-Ricardian households. As a practical matter, however, we find that there is only a fairly small chance that government spending shocks crowd in aggregate consumption, mainly because the estimated share of non-Ricardian households is relatively low, but also due to the large negative wealth effect induced by the highly persistent nature of government spending shocksfiscal policy, DSGE models, non-Ricardian households.