## _wp04102

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---

### I. INTRODUCTION — scope and definitions
- Goal: study how structural policies aimed at improving the efficiency of public spending can change the positive and normative interdependence pattern across countries that follows an asymmetric fiscal shock.
- Definition of “improving efficiency”: reducing the degree of monopoly power enjoyed by firms selling goods and services to the government, bringing their prices closer to marginal costs.
- Terminology: policies that imply an increase in the elasticity of substitution of government demand are referred to as “public competition policies.”
- Example policy change: shift from volume planning to value planning of public spending — economically, a change from fixing expenditure in real terms to fixing it in nominal terms, and therefore a change in the public price elasticity from zero to one.
- Historical illustration: late 1970s U.K. government shift from volume to value planning, with related reforms continuing through the 1980s.

### Microeconomic mechanism and modeling gap
- Many efficiency-enhancing measures (for example, obliging government departments to put provision of certain goods and services out to tender) can be captured by an increase in the price elasticity of demand of government expenditure.
- Standard macroeconomic models typically treat government spending as exogenous in real terms, implying a zero price-elasticity of government demand (applies in Keynesian ad hoc tradition and Real Business Cycle (RBC) models).
- New Open Economy Macroeconomics (NOEM) literature:
  - Explicitly models imperfect competition, allowing differentiation between individual goods that enter public consumption.
  - Limitation noted: aggregate public consumption is typically built in the same way as private consumption, with the same elasticity of substitution between differentiated goods produced in the economy. This rules out analyzing structural government policies that alter the elasticity of substitution in public consumption without affecting the private elasticity.
  - The paper develops a NOEM model in which private and public elasticities can be separated, filling this gap.

### Positive effects of public competition policies (model outcomes)
- Reduction of the negative effect on relative (i.e., domestic minus foreign) consumption that usually follows a balanced-budget asymmetric fiscal shock.
- Country implementing a balanced-budget fiscal shock still loses, in terms of short-run consumption, relative to the foreign country, but the international consumption gap can be reduced by public competition policies.
- Increase in the elasticity of substitution implies a larger expenditure switching effect.
- The short-run increase in relative output following a fiscal shock can be quantitatively bigger when public competition policies are implemented, even with a less depreciated exchange rate.

### Normative effects and welfare implications (overview)
- Implementation of public competition policies raises the level of welfare of the country with a larger public sector at foreign expense.
- Paper structure:
  - Next section introduces the model.
  - Section III investigates the positive effects of public competition policies, using numerical examples based on reduced forms derived from a linearized version of the model.
  - Section IV discusses welfare results.
  - Section V concludes.

### IV. Welfare effects: framework and metric
- Welfare metric: representative agent's lifetime real utility derived from the utility function (1), focusing on real components and assuming welfare effects of changes in real balances are negligible.
- Welfare change computed as R = dU / R_SS_U, where R_SS_U is lifetime real utility at the initial preshock steady state and dU is obtained by totally differentiating (1).
- Given the model dynamics (new steady state reached in the period after the shock), the total welfare change used is presented in the source as:
  - 22
    1
    ()
    R
    SSSS
    dUc    kYyc    kYy
    δ
    =−    +  −

- Numerical welfare calculations reported use the parameterization from Section III and k=0.1.

### Numerical welfare results (Table 2)
- Table 2 reports overall welfare changes (in the Home minus Foreign sense) following a domestic balanced-budget fiscal shock for different values of η.
- Reported welfare changes (Home and Foreign) for each η:
  - 1.1η= : Home = 0.25 ; Foreign = -0.59
  - 4η= : Home = 0.29 ; Foreign = -0.65
  - 6ηθ== : Home = 0.32 ; Foreign = -0.70
  - 10 η= : Home = 0.37 ; Foreign = -0.77
  - 20 η= : Home = 0.50 ; Foreign = -0.93
  - 100η= : Home = 1.35 ; Foreign = -1.84

### Interpretation of welfare results
- The domestic country experiences an overall positive welfare effect from its own balanced-budget fiscal expansion, while the foreign country experiences an overall negative welfare effect under the calibration used.
- Key mechanisms:
  - Short run: domestic private consumption falls relative to foreign, and domestic short-run output increases (reduced leisure), tending to reduce domestic welfare relative to foreign if considered alone.
  - Long run: domestic output falls and foreign output increases, associated with higher leisure for domestic residents and lower leisure for foreigners; long-run leisure gains for Home can more than offset short-run consumption losses for Home in the calibrated example.
- Effects of public competition policies (increases in η):
  - Increasing η increases the positive response of Home welfare.
  - Increasing η increases the negative response of Foreign welfare.
- Contrast with Obstfeld and Rogoff (1996): whereas Obstfeld and Rogoff state that “overall Foreign benefits and Home loses when Home's government spends more,” in this model and calibration Home gains overall and Foreign loses.

### Policy implications and normative insight
- Public competition policies (higher η), modeled as increases in the price elasticities of government consumption (e.g., competitive tendering, switching from volume to value planning), tend to:
  - Reduce the fall in domestic relative private consumption following a domestic fiscal expansion.
  - Magnify the long-run leisure gains for Home and deepen Foreign welfare losses.
- Normative interpretation: countries with a larger government sector may have an incentive to promote structural reforms of public spending (higher η), since such reforms can widen the welfare gap in favor of the reforming country.

*Source: Excerpt from _wp04102 (Sections I, IV, V and REFERENCES of the supplied document).*

### References..............................................................................................................

### References................................................................................................................................21

### I. INTRODUCTION — scope and definitions
- Goal: study how structural policies aimed at improving the efficiency of public spending can change the positive and normative interdependence pattern across countries that follows an asymmetric fiscal shock.
- Definition of “improving efficiency”: reducing the degree of monopoly power enjoyed by firms selling goods and services to the government, bringing their prices closer to marginal costs.
- Terminology: policies that imply an increase in the elasticity of substitution of government demand are referred to as “public competition policies.”
- Example policy change: shift from volume planning to value planning of public spending — economically, a change from fixing expenditure in real terms to fixing it in nominal terms, and therefore a change in the public price elasticity from zero to one.
- Historical illustration: late 1970s U.K. government shift from volume to value planning, with related reforms continuing through the 1980s.

### Microeconomic mechanism and modeling gap
- Many efficiency-enhancing measures (for example, obliging government departments to put provision of certain goods and services out to tender) can be captured by an increase in the price elasticity of demand of government expenditure.
- Standard macroeconomic models typically treat government spending as exogenous in real terms, implying a zero price-elasticity of government demand (applies in Keynesian ad hoc tradition and Real Business Cycle (RBC) models).
- New Open Economy Macroeconomics (NOEM) literature:
  - Explicitly models imperfect competition, allowing differentiation between individual goods that enter public consumption.
  - Limitation noted: aggregate public consumption is typically built in the same way as private consumption, with the same elasticity of substitution between differentiated goods produced in the economy. This rules out analyzing structural government policies that alter the elasticity of substitution in public consumption without affecting the private elasticity.
  - The paper develops a NOEM model in which private and public elasticities can be separated, filling this gap.

### Positive effects of public competition policies (model outcomes)
- Positive (quantitative) effects:
  - Reduction of the negative effect on relative (i.e., domestic minus foreign) consumption that usually follows a balanced-budget asymmetric fiscal shock.
  - Country implementing a balanced-budget fiscal shock still loses, in terms of short-run consumption, relative to the foreign country, but the international consumption gap can be reduced by public competition policies.
  - Increase in the elasticity of substitution implies a larger expenditure switching effect.
  - The short-run increase in relative output following a fiscal shock can be quantitatively bigger when public competition policies are implemented, even with a less depreciated exchange rate.

### Normative effects and welfare implications
- Implementation of public competition policies raises the level of welfare of the country with a larger public sector at foreign expense.

### Modeling and empirical work plan (paper structure)
- Sectional plan as presented:
  - Next section introduces the model.
  - Section III investigates the positive effects of public competition policies, using some numerical examples based on the reduced forms derived from a linearized version of the model.
  - Section IV discusses some welfare results.
  - Section V concludes.

*Source: Excerpt from the content unit provided in _wp04102 - References..............................................................................................................*

### Section IV.

### Section IV.

### Welfare effects: framework and metric
- Welfare is measured using the representative agent's lifetime real utility derived from the utility function (1), focusing on real components and assuming welfare effects of changes in real balances are negligible.
- Welfare change is computed as R
  = dU / R
  SS
  U, where R
  SS
  U is lifetime real utility at the initial preshock steady state and dU is obtained by totally differentiating (1).
- Given the model dynamics (new steady state reached in the period after the shock), the total welfare change used is:
  - 22
    1
    ()
    R
    SSSS
    dUc    kYyc    kYy
    δ
    =−    +  −
- The numerical welfare calculations reported use the parameterization from Section III and k=0.1.

### Numerical welfare results (Table 2)
- Table 2 reports overall welfare changes (in the Home minus Foreign sense) following a domestic balanced-budget fiscal shock for different values of η.
- Reported welfare changes (Home and Foreign) for each η:
  - 1.1η= : Home = 0.25 ; Foreign = -0.59
  - 4η= : Home = 0.29 ; Foreign = -0.65
  - 6ηθ== : Home = 0.32 ; Foreign = -0.70
  - 10 η= : Home = 0.37 ; Foreign = -0.77
  - 20 η= : Home = 0.50 ; Foreign = -0.93
  - 100η= : Home = 1.35 ; Foreign = -1.84

### Interpretation of welfare results
- The domestic country experiences an overall positive welfare effect from its own balanced-budget fiscal expansion, while the foreign country experiences an overall negative welfare effect under the calibration used.
- Key mechanisms behind the results:
  - Short run: domestic private consumption falls relative to foreign, and domestic short-run output increases (reduced leisure), tending to reduce domestic welfare relative to foreign if considered alone.
  - Long run: domestic output falls and foreign output increases, associated with higher leisure for domestic residents and lower leisure for foreigners; these long-run leisure gains for Home can more than offset short-run consumption losses for Home in the calibrated example.
- The implementation of public competition policies (interpreted as increases in η) unambiguously magnifies the welfare differential:
  - Increasing η increases the positive response of Home welfare.
  - Increasing η increases the negative response of Foreign welfare.
- The welfare ranking contrasts with the statement in Obstfeld and Rogoff (1996) that “overall Foreign benefits and Home loses when Home's government spends more”; in this model and calibration, Home gains overall and Foreign loses.

### Policy implications and normative insight
- Public competition policies (higher η), modeled as increases in the price elasticities of government consumption (e.g., competitive tendering, switching from volume to value planning), tend to:
  - Reduce the fall in domestic relative private consumption following a domestic fiscal expansion.
  - Magnify the long-run leisure gains for Home and deepen Foreign welfare losses.
- A way to interpret the normative results: countries with a larger government sector may have an incentive to promote structural reforms of public spending (higher η), since such reforms can widen the welfare gap in favor of the reforming country.

*Source: Author’s calculations (excerpt from Section IV and V of the supplied document).*

### REFERENCES

### REFERENCES

### Monopolistic Competition and Aggregate Demand
- Blanchard, O.J., and N. Kiyotaki, 1987, “Monopolistic Competition and the Effects of Aggregate Demand,” American Economic Review, Vol. 77, pp. 647–66.
- Gali, J., 1994, “Monopolistic Competition, Business Cycles and the Composition of Aggregate Demand,” Journal of Economic Theory, Vol. 63, pp. 73–96.
- Rotemberg, J., and Woodford, M., 1992, “Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity,” Journal of Political Economy, Vol.100, pp. 1153–1207.

### New Macroeconomics and Imperfect Markets
- Dixon, H., and N. Rankin, 1995, The New Macroeconomics: Imperfect Markets and Policy Effectiveness, (Cambridge: Cambridge University Press).
- Ganelli, G., and P. R. Lane, 2003, Dynamic General Equilibrium Analysis: The Open Economy Dimension, S. Altug, S., Chadha, J., Nolan, C. (Eds.), Dynamic Macroeconomic Analysis, (Cambridge University Press).

### Government Spending, Fiscal Policy, and Government Debt
- Ganelli, G., 2003, “Useful Government Spending, Direct Crowding-Out and Fiscal Policy Interdependence,” Journal of International Money and Finance, Vol 22 (1), pp. 87–103.
- ———, 2004, “The New Open Economy Macroeconomics of Government Debt,” forthcoming in the Journal of International Economics.

### Exchange Rates and International Macroeconomics
- Obstfeld, M., and K. Rogoff, 1995, “Exchange Rate Dynamics Redux,” Journal of Political Economy , Vol. 103, pp. 624–660.
- ———, 1996, Foundations of International Macroeconomics, Chapter 10, (Cambridge: MIT Press).

### Financial Market Integration and Volatility
- Sutherland A., 1996, “Financial Market Integration and Macroeconomic Volatility,” Scandinavian Journal of Economics ,Vol. 98, pp. 521–39.

*Source: _wp04102 - REFERENCES*

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