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The implications of public expenditures on a small economy in transition: a Bayesian DSGE approach

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Abstract

This paper explores the influence of government expenditures on the business cycle dynamics of a small transition country such as Vietnam. We develop a comprehensive stochastic-growth DSGE model where government consumption may affect households’ utility function, and there is habit persistence in consumption and endogenous private capital utilisation. Two fiscal shocks are considered in addition to shocks to households’ preferences and technological progress. The estimated DSGE model adequately captures the dynamics of Vietnam’s economy and is helpful to uncover a diversity of findings. First, public investment was an important driver of Vietnam’s high output growth in the early-to-mid 1990s, although its contribution decreased during the 2000s. Second, government expenditures explain, respectively, up to 30% and 20% of Vietnamese output variations in the long and short run. Third, impulse–response functions reveal a 3% GDP cumulative 5-year gain from a public investment shock of 1% GDP. Fourth, simulation analysis of different fiscal policies unveils a significant and positive impact of productive public investment by crowding in private investment.

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Notes

  1. For instance, Abiad et al. (2016) showed that public investment could raise output in both the short- and long-term and reduce unemployment, which in turn crowds in private investment (Pereira and Andraz 2013; Dreger and Reimers 2016) and raises the marginal productivity of private capital (Cavallo and Daude 2011). Other studies show, however, that excessive and inefficient public investment may crowd out private investment and thus affect income growth negatively (Abel 2017; Cavallo and Daude 2011; Kandil 2017; Ogibayashi and Takashima 2017; among others). On a different perspective, Ilzetzki et al. (2013) documented a larger output multiplier associated to government spending in developed (closed) economies than in developing (open) economies. This multiplier was found to be zero in countries having flexible exchange rates, large in those having predetermined exchange rates, and negative in highly indebted countries.

  2. Either with an endogenous discount factor or Uzawa-type preferences; a debt-elastic interest-rate premium; convex portfolio adjustment costs; complete asset markets; or without stationarity-inducing features.

  3. We refer the interested readers to Pham et al. (2020) for further details and a complementary analysis.

  4. Christiano and Eichenbaum (1992) considered three cases of \({\pi }\). Case (i) \({\pi } = 1\) refers to the absence of a role for \({{C}}_{{{{g}},{{t}}}}\); Case (ii) \({\pi } = 0\) \({{C}}_{{{{g}},{{t}}}}\) “is formally equivalent to a pure resource drain on the economy”; Case (iii) \(0 < {\pi } < 1\) models the partial effect of \({{C}}_{{{{g}},{{t}}}}\) on the marginal utility.

  5. Cassou and Lansing (1998) developed an optimal fiscal rule for the government in which the ratio of public investment over GDP, \(\zeta_{ig}\), is determined as a function of \({\beta },{{ \alpha }}_{3} {{ and \delta }}_{{{g}}}\), i.e. \({\zeta }_{{{{ig}}}} = {{\beta \delta }}_{{{g}}} {\alpha }_{3} /\left[ {1 - {\beta }\left( {1 - {\delta }_{{{g}}} } \right)} \right]\). Here we calibrate \({\zeta }_{{{{ig}}}}\) to be consistent with Vietnam’s data.

  6. See the online technical appendix for details.

  7. Prior and posterior distributions of \(\rho_{cg}\) are not plotted as this parameter is ill-identified.

  8. Note that a higher intensity of habit formation implies that a unit of current consumption will raise the marginal utility of consumption in the next period which, as a consequence, decreases in the present period.

  9. Responses to a shock on government consumption (\(\epsilon_{{{{cg}}}}\)) are omitted due to its negligible impact.

  10. Each IRF is the median of its Bayesian responses to the respective shock computed over the MHMC draws.

  11. The corresponding individual plots with their error bands can be found in the online appendix.

  12. See the online appendix for the response curves with error bands.

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Acknowledgements

We are grateful to two anonymous referees for their insightful comments and suggestions received on an earlier version of this paper. Hector Sala is grateful to the Spanish Ministry of Science and Innovation for financial support through grant PID2019-104723RB-I00. This research is funded by the University of Economics Ho Chi Minh City, Vietnam.

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Correspondence to Binh Thai Pham.

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Pham, B.T., Sala, H. The implications of public expenditures on a small economy in transition: a Bayesian DSGE approach. Econ Change Restruct 55, 401–431 (2022). https://doi.org/10.1007/s10644-021-09319-7

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