Services spending boosts goods output via household income
An ECB working paper shows that government spending concentrated in services stimulates goods production and private consumption in an open economy. Using US data from 1954 to 2019, the study finds that borrowing-constrained households drive cross-sector spillovers.
Four facts behind the spending multiplier
An empirical analysis of quarterly US data from 1954 to 2019 reveals that an orthogonal one percent increase in government spending as a share of output raises production in both goods and services by roughly one percent.
Private consumption expands across both categories, with tradable goods experiencing a larger increase than services.
Concurrently, tradable goods become relatively cheaper and net exports deteriorate.
A two-sector open-economy Heterogeneous-Agent New Keynesian model replicates these dynamics.
In the model, 49.7 percent of households face borrowing constraints.
Deficit-financed spending increases labor demand and wages, generating persistent consumption gains.
Frictions that break representative models
Standard representative-agent frameworks fail to reproduce these dynamics, predicting consumption declines due to higher anticipated interest rates and taxes.
In contrast, the HANK model links spending spillovers to imperfect labor mobility and distribution margins.
Because workers cannot move frictionlessly between sectors, wage pressures concentrate in services, lowering the relative price of goods and inducing expenditure switching.
Local distribution costs cushion exchange rate pass-through.
Valid mechanism, limited exportability
The model successfully resolves the open-economy consumption puzzle by incorporating micro-level balance-sheet constraints.
Yet the findings rely heavily on US trade parameters and do not apply uniformly to highly open economies.
Policymakers should remember that spending gains leak abroad when domestic trade exposure is high.