The Effect of Public Expenditure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Study: Iran

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1 40 School of Docoral Sudies (European Union) Journal 2010 The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran Khosrow Pyraee a, Gholam Reza Haddad Keshavarz, Mahmoud Abol Poor Mofrad a Associae Professor of Islamic Azad Universiy of Shiraz b Associae Professor of Sharif Universiy c Faculy of Islamic Azad Universiy Firouzabad, Corresponding Auhor maab_640@yahoo.com Absrac In his research we use a real business cycle model o analyses he impac of sochasic shocks of governmen spending on macroeconomic variables by applicaion dynamic sochasic general equilibrium. Consumer preferences depend on privae and public spending and households are habi forming. Produc is ranscendenal funcion of governmen spending. The model esimaes by he maximumlikelilood mehod using Iran daa from 1338 o Esimaion resuls poin ou ha a negaive response of consumpion and following a governmen spending shock. Anoher macroeconomics like privae invesmen, capial, employmen, wages and oupu are cause a posiive response o governmen spending shock. Key words: Real business cycle, macro variables, Complemenary effecs, subsiuion effec, sochasic dynamic general equilibrium 1. Inroducion Public secor in many counries has developed in he wenieh cenury. Table 11 shows share of governmen spending in GDP for 14 indusrialized counries during he years Governmen spending in hese counries was abou 8 per cen of GDP in IT rose o 15 per cen afer worldwar I, and 30 per cen in Evenually reached up o 40 per cen of GDP in Securiy, healh, educaion and noneconomic imbalances jusify governmen inervenion in economical aciviy. According o srucure and duies, governmens go under spending ha affec macroeconomic variables. Increased governmen spending on infrasrucure such as building roads, energy, elecommunicaions, raining, increase produciviy and reduce producion coss of privae secor. I Simulae he privae secor o increase invesmen and producion and will increase consumpion in longerm. On he oher hand lack of producive resources such as labor, capial and raw maerials, and increased governmen demand for hese producive resources leads inadequae access of privae secor o resources. Table 1 share of governmen spending in 14 indusrialized counries Before World War 1 Afer World War 1 Before World War 2 Afer World War 2 Ausralia Bulgaria Canada France Germany Ialy Japan School of Docoral Sudies (European Union) Journal 2010

2 2010 The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran Before World War 1 Afer World War 1 Before World War 2 Afer World War 2 Neherlands Norway Spain Swedish Swizerland England America Mean Source: IMF Working Paper, 1995; updaed wih OECD Theoreically he relaionship beween governmen spending and economic variables is complex. In he pas, Thomas Hobbes (1950) claimed ha i is no possible o live wihou governmen. He argued he law and orders issued by he governmen are he mos crucical feaure in he modern civil. Hobbes view of he governmen s main role is proecing he righs of individuals, social sabiliy and securiy. These facors aid governmen o provide groundwork of economical growh. In addiion, despie some public goods ha markes and privae are no willing o produce i, he need for governmen inervenion in producing and disribuing of goods, makes unavoidable. Because he naure of hese goods is such he relaionship beween pay hem hrough he marke is difficul ha is roads, naional defense and securiy. Producion and disribuion of hese goods by governmen can grow and speed up economical developmen. However, as he governmen is exend more and more, more allocaes by policymakers insead of marke forces. There are hree reasons which decrease profiableness and usefulness of governmen role: Financing, higher ax and loan o finance governmen spending, could affec negaively on economical variables. Higher axes on labor, decline incenives for working and cu manufacuring aciviy. Similarly, loans slow down privae invesmen. I also boo up he incoming axes. As a resul, even if he efficiency of governmen spending do no reduce, incenive effecs of deb and ax will decline and ransfer resources from he privae o public led negaive impac on economical growh. (Gwarney e al. 1998) Size of Governmen: Public secor growh han he privae, reduce public spending efficiency. Suppose governmen firs focus o aciviies such as human righs he suppor, adopion and implemenaion of laws ha will lead o expansion of communiy jusice, creae and develop a framework of moneary sabiliy and naional defense. Which are funcions consider as essenial duy of sae. Performing hese asks inheren in he governmen for he efficien funcioning marke provides, and hus provides a conex of economical growh. If he governmen provides oher economic fields such as infrasrucure and educaion o be impored, despie he abiliy of he privae o carry ou hese aciviies, again, governmen spending will help economical growh. If governmen pays for producion and disribuion of privae goods, public secor expansion and increased governmen spending will associae wih reduced performance, and his will lessen economical growh. Finally, policy process han he marke are. Compeiion, as proper o ac agains he rewards here are also penalies for wrong decisions. Adjused o changes in he public secor is much slower han marke. Marke compared wih he ime needed o compensae for an error, for example inadequae invesmen, or adjus o changing condiions, new informaion, and echnical progress for governmen is very slow. Governmen limis, causing a grea limis o economical growh. This paper will ry o answer he quesion wheher he rend of changes in macro variables affec changes in public spending. In his sudy we use he exended real business cycle model, apply following consideraion and research mehods. Governmen spending used as a variable in he represenaive household uiliy funcion and producion of firms Use of governmen spending in uiliy has been done by some researchers. For example, Barrow (1981), Karas (1994), Baxer and King (1993) and Rag Murcia (2003) can noed. Bu governmen spending enering o producion funcion in real business cycle sudies no remarked. According o he funcion shows a echnical relaionship among he facors of producion and ou pu. Governmen spending on consumpion following o builds infrasrucure and buy goods and services produced as a producive facor acs. Using governmen spending in he producion, he marginal producion affec as governmen spending rise. As a resul he producion, including he use of capial will be affeced. Thus, change in governmen spending, leading o changes in hese facors is he marginal producion. Therefore, affec he rae of facor employmen including capial spending. This way can help o analyze he effecs Pyraeea K., Haddad K. G. R., Poor M. M. A. The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran

3 42 School of Docoral Sudies (European Union) Journal 2010 of governmen spending on invesmen and producion. We also assume household behavior is habiual. This means he household curren consumpion affec by prior consumpion placed. Therefore, pre consumpion eners as an argumen o uiliy funcion. The idea is ha choices consumer overime also affec he consumpion and pas consumpion are desirable due o he influence. Especially if he consumpion in he pas been a pleasure for he individual, he ries o keep his curren choices based on ha level. If households are habi behavior, smooh and uniform Consumpion level and is rae of change. Because only changes he curren income does no considered. Therefore, aking he shock reacion in he consumer behavior model ha households affeced by pas consumpion habis less han he model ha consumer behavior is no habiual. Organizing paper is as follows. In he second par will be paid o he heoreical foundaions. Secion III presens mehod. Esimae and solve he model is given in Secion IV. Five secions devoed o solving he model, and finally in secion six summary and conclusions are presened. 2. Theoreical Foundaions According o he heory of Lucas (1977), economic cycles oscillaions in producion and employmen which have special characerisics. Mos imporan characerisics is he variaion around he longerm rend of variables and influence he longerm growh in similar direcion (Karagedikli, e al. 2007) In 1960 and 1970 decades moneary policy considered as he main iem of all business cycle. Many analyss believed he main cause of business cycles and inflaion is money supply growh rae. This view largely presened by Milon Fredman and shoary ( ). Edward Presco (1986) in an aricle showed afer Worldwar II, he business cycle creaed because of sochasic changes in he echnology. The sudy by Presco and Kydland (1982), John Long and Charles Plosser (1983) implies his heory as real business cycle heory sresses nonmoneary facors i.e. populaion growh echnological innovaion and consumer preferences as deerminans of he real growh. According o economic heory, when he marke surpluses or shorages arise wages and prices will be adjused and sand economy close o longerm raes of growh. If real shocks causes change in echnology or economic wealh, make a mess ino economic balance, here would appear a business cycle. Real shocks may appear in various forms such as cuing off oil supply in 1970 and a decrease in oil prices in Demand shifs from one secion o anoher and changes in fiscal policy or a echnological change in he machinery also are as real shocks. (Walsh : 1980) Analysing periodic variaion of macro variables such as GDP, invesmen and... Gradually exended he research area o exrac realiies abou differen counries forever i explains heories on economical cycle. Theoreically, here is no a general agreemen on reacion of key variables such as consumpion, invesmen and producion o changes in financial. Since such difference may come from he difference in specify he model, used policies and research mehod. Here we explain some differen heoreical economic models. Neoclassical model: The mos imporan heoreical improvemen in recen decade, becoming illuminaion of fiscal policy in neoclassical model resuling of research by Lyagaly e al (1992) and Baxer and King (1993). In his model, fiscal policy mosly influences represened agens hrow, he wealh effec of fiscal policy. When governmen spending increases, and also axes. The represenaive household wealh reduced equivalen. As a resul he reducion in household wealh, he purchase of goods and leisure reduce which boh are normal goods. As a resul, privae consumpion would be diminished. Labour supply increases and real wages are reduced. Since he longerm work/ invesmen is deermined by ime preferred raes, so i will no change. Therefore as he denominaor of he fracion has increased, mus also deduc numeraor proporionally increases as well. Thus he invesmen would increase o yield a desirable capial sock. Boos up labour supply increases marginal producion of capial and invesmen will increase. In long run less consumpion, invesmen and employmen. I forced real wages ge back o is prior amoun. Expanded neoclassical model by alia Galy e.al (1992) and Baxer and King (1993) based on real business cycle models sandards become a general ool o analyse fiscal policy. In his model, periodic complemenariy of work supply is a key parameer. The larger value of his subsiuion shows more growh in employmen since shocks on governmen spending. The final oucome is increase in invesmen. New Keynesian model: This model recenly expanded by Lopez and colleagues (2005), and considered as he opposie of neoclassical view. In his model, empirical School of Docoral Sudies (European Union) Journal 2010

4 2010 The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran 43 evidence suggess posiive effecs of governmen spending on privae consumpion. Rigid prices, non Ricardian households which follow he ruleofhumb in heir consumpion behavior. And aking i as a funcion of heir curren income and noncompeiive labour marke. Wages se by unions and firms. Households end o responds hose firms ha accep o he wages se by unions. In his heory, public spending and privae consumpion are complemenary. Because under rigid prices, a rise in governmen spending increases aggregae demand, firms increase producion. Then firms rise demand for workers. Because of he monopoly of a labour marke, his increases real wages srongly and hus earnings of nonricardian households go up. This incenive hem o increase heir consumpion. If he weigh of such households in he communiy is large enough, he oal consumpion will increase. Ricardian equivalence mehod: This mehod expanded by Barrow (1989). Based on hese idea, a rise in he defici from he increase in governmen spending, or should be refunded in presen or fuure. As he presen value receips are equal he presen value of spending, so a relaive decline in axes oday should be offse by fuure increases in axes. Since he ineres rae does no change, he invesmen will no change. In oher words, he expeced increase in fuure axes, consumers are saving more in he fuure o be able o pay addiional axes and reducing axes equivalen o he increase in savings. Therefore, he oal savings rae remains consan and will no change. As a resul privae invesmen does no change. ω, shows ha governmen spending how much will affec desirabiliy. If ω = 1, he general view of he consumer governmen spending has no share in consumpion. And if ω =. 5, he role of public and privae goods in consumpion is seen as idenical. τ is elasiciy subsiuion beween privae consumpion and governmen spending. If τ=0, hen privae consumpion and governmen spending are he perfec complemen. And if τ hey will perfec subsiuion. Presened as a funcion (CES) is caused o achieve a cerain level of effecive consumpion, diminishing marginal uiliy o governmen spending and privae consumpion is esablished. The household uiliy is separable funcion of effecive consumpion and leisure. ε is he risk aversion parameer. θ Parameer and ( 0,1) γ represens he degree of household habiual behaviour. If γ = 0, hen household curren consumpion behaviour does no in erm of prior consumpion. The above uiliy funcion should be placed on he following heoreical erms. Funcion mus be direc oward effecive consumpion and leisure. 3. Mode In his sudy, we are going o use he exended sandard real business cycle (RBC) model which include hree secors. Household, firms and governmen Represenaive household: Assuming ha household drows is uiliy from ~ ( C ) Effecive consumpion and leisure where held from L =(1N ) N, is working hours and L is leisure. I is assumed ha in each period, he represenaive household endowed one uni of ime ha divided beween labour and leisure. Effecive consumpion provides as a funcion wih consan elasiciy subsiuion (CES) of privae consumpion (C) and governmen spending (G): If he second derivaive o hese wo variables is negaive, hen uiliy has maximum value. And if one is fixed while anoher increase, oal compliance wih diminishing raes rise up and he graph will be hump. In oher words, he diminishing marginal uiliy on leisure and effecive consumpion is esablished. Firs and second order derivaive uiliy funcion o include leisure and effecive consumpion are as follows; Pyraeea K., Haddad K. G. R., Poor M. M. A. The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran

5 44 School of Docoral Sudies (European Union) Journal 2010 educaion, research and buy goods produced by firms. Producion is ranscendenal funcion as presened below. If ε > 0, hen he firs and second derivaive o consumpion is posiive and has diminishing rae. If φ> 0 i se up o leisure oo. Household disposable income o consumpion and invesmen offers. Invesmen in each period increased capial socks of households in he nex period. So can wrie K = (1 δ ) K I 3 Is capial socks of household in period. Is he depreciaion rae. Household budge consrain in period is: In Equaion 5, A is echnology coefficien. since in his sudy on he effecs of echnical shocks on macroeconomic variables is no consider, wihou suffered in generalizaion of model, he coefficien of echnical progress assumes equal o one. Each firm chooses workforce and capial o maximize is profi. Profi maximizaion yields he Inpu demand equaions as follows: C + I = w N + r K T 4 w Is real wages paid o labour, r real renal rae of capial and T Lump sum axes. Represenaive household uiliy funcion relaed o he period of his life presened as follows. Which sae ha each facor mus earn is marginal produc Governmen U = E β s= s ~ ~ u C, C ( 1, L ) Governmen spending financed by axaion which equivalen o axes. Household maximizes is uiliy funcion subjec o 1, 3 and 4. E Is expecaion operaor formed in period based on informaion a his period. The reason using presen value of uiliy expecaions is he uncerainy in he esimaed Ineres rae and wages for households in he fuure. Therefore, households will no choose a cerain pah for consumpion, savings and labor supply. Is choose in each period depends on all economical shocks. These shocks may be caused by governmen spending, echnology or oher iems. Therefore, he model presened on uncerainy. Firs order condiions obained for opimal value C, N, K Firms Firms hire labour and ren capial, combining hem o produce goods and services. Governmen can simulae firms o increase producion hrough invesmen, Governmen spending is o be a sochasic variable and follows a firsorder auoregressive given by: ( 1 ρ G ) ln G + ρg ln G + G ln G µ = 1 Where 1 < ρ G < 1 and µ G has normal disribuion wih mean zero and σ sandard deviaion General equilibrium and marke clearing requires ha: µ G ( 1 ρ G ) ln G + ρg ln G + G ln G µ 9 = 1 In his model, solving is simply is he proper values ~ of nine ime series ( G, C, C, N, I, K + 1Y, w. r ) which saisfy equaions (1) o (10) and he firs order condiions. School of Docoral Sudies (European Union) Journal 2010

6 2010 The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran Mehod of solving algebraic model As menioned above, represenaive households maximize lifeime uiliy funcion hrow choose subjec o he relaions 1, 3 and 4. Mahs can wrie as: ST: K K + I C + 1 = (1 δ ) + I = w N + r K T Subsiuing C ~ from equaion 1 ino Objecive funcion and I obained from equaion 3 ino equaion 4 we can wrie Lagrange equaion as: Mainly in papers presened o resolve his problem, used numerical soluion. In his way, parameer values calculae on previous sudies and he resricions on hem. So we can analyse he variance covariance variables based on parameers se. And analysis he reciprocal effecs of variables.. In This approach he source of influence is no clear (Campbell: 1994). He suggess ha insead of numerical mehod, using firs order Taylor series expansion, he equaions can be exended. herefore, he equaions in he model, expanded on relaive logarihmic around Seady sae value of variables. Then he approximaion properies reviewed. In his way, equaions are wrien on logarihmic deviaion of he logarihm of each variable from is Seady sae. In oher words, he model is LogLinearized. To conver he model equaions o LogLinearized, relaionships (1) o (13) is wrien for he case he model is in Seady sae. To obain he seady sae equaions, we remove ime index and expecaions of variables, and equal all shocks o zero. Seady sae equaions are as follows. λ is Lagrange coefficien. Firs order condiions for maximizing uiliy funcion will calculae for C, N and K +1. Wih differeniaing Lagrange equaion oward above variables, Lagrange coefficien for he following hree relaionships are; K = ( 1 δ ) K + I λ on equaion 11 represens marginal uiliy of consumpion. And in equaion 12 he marginal subsiuion rae of consumpion and leisure equal o real wages. In 13 i is he marginal value of capial. Equaions 1 o 13 depic a se of simulaneous equaions. Solving hem, we obain a general compeiive equilibrium. Almos all he real business cycle models could no solve analyically and algebraic. (Campbell: 1994). To LogLinearized model, we apply equaions 1 o 13 and Seady sae equaions 14 o 22. LogLinearized equaions presened as follows. Pyraeea K., Haddad K. G. R., Poor M. M. A. The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran

7 46 School of Docoral Sudies (European Union) Journal 2010 (25) Sae variables are such variables ha all is informaion in he curren period (period ) is available (predeermined variables). Wih his daa se, we can predic presen and fuure behaviour of variables. Solving algorihm shows in Figure 2 Figure 2 Char sysem solving mehods Sep 1 and are deerminae. Vecor calculae. 26 Sep 2 and are deerminae. Vecor calculae. Sep 3 and are deerminae. Vecor calculae. ( 1 α ) Nˆ γgˆ Yˆ = α Kˆ The sochasic process of he shocks, (9) is: The above simulaneous equaions sysem can pu o sae space form: ˆ~ ` Where Μ = ( 1, 1, 1) G K C sae variables vecor, Γ vecor ha conains he forwardlooking Variables, H, K are marices, which elemens are combinaions of he model parameers. And finally µ = µ G Subsiue Equaion 33 in Equaion 34, endogenous variables in he curren period calculaed in erms of sae variables, which represen he policy funcions. These funcions are obained by he solving model. 29 Variables in period are given. And shock on he sysem occurs in he period. Therefore, all he endogenous variables including idenify in period. Occurrence of shocks in he period +1 and exisence sae variables in his period, he endogenous variables for period +1 are calculaed. And his goes on and deermines he Fuure opimal pah variables. Coefficiens of model are esimaed on maximum likelihood (ML). Then he effec of governmen spending shocks examined on invesmen, consumpion and oher variables. Number of observed variables should no exceed he number of srucural shocks in he model. Oherwise he marix variance covariance will be singular. In his case, i is impossible o esimaing parameers. Therefore, in his sudy o esimae he parameers, we use daa of one variable. To solve and esimaing he model, we use daynare sofware which works under lip Ma programming designed o solve real business cycle models, srucured and expanded by Michel juillard and O.CameniK in Paris. This is a high power engine designed o simulaion and esimaion of Dynamic Sochasic General Equilibrium (DSGE) models. Model has 10 endogenous variables and an exogenous variable governmen spending shock ( ). Firs, using daa from Iran and maximumlikelihood mehod o esimaes he parameers of he model. Then apply he esimaed parameers o solve sysem equaions. Solve he sysem includes Seady sae values, simulaed values of endogenous variables, variance and covariance marix of variables, policy funcions and Impulse Response Funcion ha come looking. School of Docoral Sudies (European Union) Journal 2010

8 2010 The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran Resuls Seady sae resuls presened in Table 2. Variables Table 2: Seady sae variables Seady sae Domesic Gross Producion(GDP) Consumpion(C) Governmen Expendiure(G) Effecive Consumpion( ) Wage(W) Employmen(N) Inres(r) Invesmen(I) Capial(K) Lagrange ( λ) Source: research findings Terms Blanchard Kahn se up. Which says for he exisence of a unique sable equilibrium in he near of Seady sae, require he number of eigenvalues greaer han one equal o ForwardLooking variables. Model has hree ForwardLooking variables and he same number of eigenvalues greaer han one exiss. Esimaed parameers of he model Presened in Table 3. All parameers are significan in he 95% confidence level. As sae in Chaper 3, is subsiuion elasiciy beween privae consumpion and public spending. Whenever value of his parameer is smaller, complemenary beween hese wo variables are greaer. Considering he esimaed value of his parameer is small, herefore, increased privae consumpion follow increase governmen spending. η, he producion elasiciy of governmen spending is posiive, indicaes increase in governmen spending could increase producion. I would moivae o increase consumpion and producion, marginal producion of labour and capial increase and causing increase wages and ineres rae. γ is he habiual degree of consumers. Which is significanly differen from zero. Therefore can be concluded ha households consider heir previous consumpion in heir curren consumpion behaviour. Being small, i poins ou in uiliy funcion, he curren consumpion has greaer imporance han las period consumed. ( ) is he weigh of governmen spending in he effecive consumpion index which esimaed value equal o Therefore, households evaluae he share of governmen spending in effecive consumpion raher low. I would formed he households expecaions o increase governmen spending. As a resul, i makes he governmen forced o rise he consumpion spending share, especially increase subsidies. Table 3: Esimaed parameers Parameers Esimae Sandard deviaion saisic α ϕ ω β δ τ ρ η ε γ Source: research findings Marix coefficiens of Policy funcions shows in Table 4. In hese funcions, each endogenous variable in he model based on he curren period sae variables and shocks in he las period.. In his model, are sae variables and oher variables in he curren period can be wrien in erms of hem. For example, opimal consumpion pah is defined as: Symbol ^ indicaes he deviae of he logarihm variable from is Seady sae logarihm. For example; where C shows Seady sae of C. Coefficiens of variables in he log linear form in equaions represen he elasiciy of hem. So can wrie Pyraeea K., Haddad K. G. R., Poor M. M. A. The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran

9 48 School of Docoral Sudies (European Union) Journal 2010 Simpler words, marix elemens show ineracion elasiciy of he variables. Consumpion elasiciy oward governmen spending shocks in previous period is negaive represens a negaive reacion of consumpion o governmen spending shocks. Policy funcion for invesmen is as follows. As we can see coefficiens of variables are posiive. This shows governmen spending shocks impose posiive effec on invesmen. And an increase in public spending in he curren period would increase invesmen in he nex period. I indicaes ha privae invesmen and governmen spending are complemenary. Similarly, he ineracion variables can be examined. e_g shows unanicipaed governmen spending Shocks. Marix elemens indicae he shock has a posiive effec on oher variables. Table 4 policy marix funcions (ransiion) variables Cosan cile(1) g (1) k (1) e_g Domesic Gross Producion(GDP) Consumpion(C) Governmen Expendiure (G) Effecive Consumpion ( ) Wage(W) Employmen(N) Inres(r) Invesmen(I) Capial(K) Lagrange ( λ ) Source: research findings effecs on privae consumpion was iniially negaive and afer a cerain period conver o posiive. In oher words, he shock in shorerm has negaive impac bu posiive in longerm. In firs sep i increase wih increasing rae over ime, hen by diminishing rae coninues is increase. The shock imposes GDP in posiive diminishing rae. In he early period, i increases fairly seep and hen genly coninues. Impulse Response Funcion shows ha governmen spending Shock effec on invesmen is posiive hrough he sudy period. I rapidly reduced in early period, hen wih a genle slope will end owards posiive value. Pah of capial socks is posiive and rising. As his could be due o which capial is as a sorage and invesmens in each period is added o prior capial socks. And when shock has a posiive effec on invesmen, i will increase capial socks. The effec of shock on governmen spending is posiive and decreases wih a genle rae. This effec a he end of he period of sudy will end o some posiive consan. Shock effec on employmen was posiive and had a mild decline during he period. The increasing rae decreases overime during he period sudied and remain posiive. So we can say governmen spending can lead o increased employmen overime. Wage pah, is posiive and increases wih diminishing rae. This can be caused by he shock effec on increased demand labour exceeds supply. Effecive consumpion will ge hrough posiive direcion over ime. Shock impac on λ firs is posiive bu scale down. Afer being zero a he beginning of he period, bu decrease he negaive direcion will ge hrough o reach is minimum poin. The pah is decline seep up o he end of he sudy and remains negaive. Reverse direcion when λ is as he marginal uiliy of so λ is decline as consumpion increases and conversely. Reducion in λ during he period sudied, indicaes he pah of consumpion and invesmen is upside during he period. Figure 1 shows he Impulse Response Funcions. Impulse Response Funcions (IRF) represens he fuure opimal expeced pah of variables o achieve nex equilibrium poin afer occurring shock equal o one sandard deviaion of disurbance in curren period. In his sudy, he effec sudied for 40 periods afer he shock. Impulse Response Funcions shows ha Shock School of Docoral Sudies (European Union) Journal 2010

10 2010 The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran 49 Baxer,M. and R.G. King.(1993) Fiscal Policy in General Equilibrium American Economic Review 83, pp Bayrakar, N. & Moreira, E.( 2007) The composiion of Public Expendiure And Growh: A SmallScale Iner emporal Model For Low Income Counries Working Paper, World Bank, Conclusion Securiy, healh, educaion and noneconomic imbalances are jusify governmen inervenion in economical aciviy. According o srucure and duies, governmens go under spending ha a effec macroeconomic. Increased governmen spending on building roads, energy, elecommunicaions, raining, increase produciviy and reduce producion coss of privae secor. I Simulae he privae secor o increase invesmen and producion and will increase consumpion in longerm. On he oher hand lack of producive resources such as labour, capial and raw maerials, and increased governmen demand for hese producive resources leads Inadequae access of privae secor o resources. Governmen spending can impac on producion, consumpion and welfare hrough efficiency. Buying final goods makes he firms o increase heir producion. This leads o employmen growh which rises he consumpion and welfare. Resuls show ha consumpion and governmen spending are subsiuion. The resuls confirm he research in real business cycle models and inconsisen wih evidence and he resuls of sudies in new classical model. More governmen spending simulaes oher variables and increases hem. References Abbasian, E. Noorizade, R(2007) The Ricardian equivalence Tes in Iran Journal of Iran Economic Research No. 79 Barro, R.J. (1990) Governmen Spending in a Simple Model of Endogenous Growh Journal of Poliical Economy 98, pp Beesma,R e al.(2006) Trade Spillovers of Fiscal Policy in he European Union : A Panel analysis Universiy of Amserdam Berumen, H&Burak,D.(2003) The Asymeric Effecs of Governmen Spending Shocks: Emperical evidence From Turkey Journal of Economic and Social Reaserch, No.6, vol.1, pp 3351 Bouakez, H &Nooman,R.(2006) Why Does Privae Consumpion Rise Afer a Governmen Spending Shock? of Inernaional Economics, No. 66 Emad M.A(2006) Crowdingou and Crowdingin Effecs of Governmen Bonds Marke on Privae Secor Invesmen (Japanese Case Sudy) Insiue of Developing economies, Discussion Paper No74 Gaskari, R. and Ghanbari, H (2006) Macroeconomic insabiliy and privae invesmen in Iran Quarerly economic Research bullein, No. 22 Ghali, K. (1997) Governmen Spending And Economic Growh in Saudi Arabia Journal of Economic Developmen, vol. 22, No 2 Gali,J&Salidoo,D&Valles,I.(2006) Undersanding he Effecs of Governmen Spending on Consumpion Journal of he European Economic Associaion, No.5, pp Grimes, A. (2003) Economic Growh And Size & Srucure of Governmen: Implicaions for Newzland Universiy of Waikao Pyraeea K., Haddad K. G. R., Poor M. M. A. The Effec of Public Expendiure Shocks on Macroeconomic Variables in a Real Business Cycle Model. Case Sudy: Iran

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