Fiscal Shocks and the Consumption Response when Wages are Sticky

Abstract

In this paper we study the impact of a government spending shock on aggregate consumption, building on the GLV (Gali, Lopez-Salido and Valles (2007)) model. We show that the GLV model implies a counterfactual increase in the real wage, the interest rate and the in.ation rate. The introduction of sticky wages solves these problems and preserves the main result of the model, i.e. the positive response of consumption. Moreover, once we relax the common wage assumption, sticky wages are even essential to reproduce the positive response of consumption.sticky wages; rule-of-thumb consumers; fiscal shocks; firm-specific capital