a1 University of California, Los Angeles
This paper uses the old Keynesian representative agent model developed by Roger E. A. Farmer [Expectations, Employment and Prices. New York: Oxford University Press (2010)] to answer two questions: (1) Do increased government purchases crowd out private consumption? (2) Do increased government purchases reduce unemployment? Farmer compared permanent tax-financed expenditure paths and showed that the answer to (1) was yes and the answer to (2) was no. We generalize his result to temporary bond-financed paths of government purchases that are similar to the actual path that occurred during WWII. We find that a temporary increase in government purchases does crowd out private consumption expenditure as in Farmer. However, in contrast to Farmer's experiment, we find that a temporary increase in government purchases can also reduce unemployment.
We wish to thank the National Science Foundation for funding this research under Grant 0720839. We would also like to thank a referee of this journal for his/her helpful comments. The title of the paper is borrowed from Blinder and Solow (1973), who asked the same question nearly 40 years ago in the context of the IS-LM model.