The Effects of Government Expenditure Shocks on Input Efficiency and Consumer Preferences in Iran

The role of public sector expenditure shocks in the economy has always been of interest to policymakers and economists.  The government expenditures include government consumption and investment. This study investigates the effects of government expenditure shocks on macroeconomic variables for the annual data during 1978-2016 in Iran. In particular, the effects of government expenditure shocks on product variables, private sector consumption, private sector investment, real wages, and employment are examined. In addition, in the present study, the effect of government expenditure on household and enterprise behavior has been investigated. Therefore, the role of government investment through the production function and the role of government consumption through the utility function have entered the model. The model, appropriated for Iran’s economy, is designed in such a way that the monetary rule of the Central Bank of Iran would be based on the amount of money and also the government budget would be based on oil revenues, taxes, bonds and loans from the Central Bank. Finally, the model is estimated for the Iranian economy. The advantage of this model over other studies in Iran is the simultaneous investigation of the effects of various types of government expenditure on the inputs efficiency and consumer preferences. In other words, the model includes the impact of public sector investment on improving the efficiency of enterprises and dependence of consumer preferences on government consumption. The features of the model used in this research include having the fundamentals of microeconomics, nominal rigidity, incomplete competition market, and general equilibrium. The sections of model include households, enterprises, government, and the central bank. Since the model is random, it is possible to study the effects of nominal and actual shocks on key variables of the economy. In other words, the new Keynesian Dynamic Stochastic General Equilibrium (DSGE) has been used to estimate the model. After solving the model, the system of linear equations by Bayesian method is estimated for the Iranian economy. The estimation results show that public sector investment has a direct effect on the production function and also government consumption has a direct effect on the utility function. The Markov-Chan-Monte-Carlo (MCMC) univariate and multivariate convergence tests, the matching of the prior and posterior distributions, as well as the final likelihood value were used to evaluate the model. Moreover, the model was evaluated through   matching simulation diagrams of variables and shocks. According to the results obtained from evaluation, this model seems appropriate for the Iranian economy. The immediate responses of government consumption and investment shocks to the variables of product, private sector consumption, private sector investment, real wages, and employment are examined. The effects of government consumption and investment shocks are also compared. The results show that in Iran, the accumulation of public investment improves the efficiency of enterprises. Moreover, consumer preferences are influenced by government consumption. In addition, the government consumption shock increases private sector investment, product, employment and real wages. The positive government investment shocks also increases efficiency, employment, real wages and reduces private consumption. On the other hand, there is also a complementary relationship between public and private investments. It seems that government investment can increase private sector investment by creating and expanding infrastructure. The results emphasize the role of the positive shock of government investment in improving economic conditions. Based on the findings, it seems important to pay attention to the role of government expenditure policies in dealing with the recession.