Government Spending, Entry and the Consumption Crowding-in Puzzle

This paper documents empirically that net firm entry robustly rises after a US government spending expansion. We use this new finding to test the empirical validity of various model features that have been put forward to generate a crowding-in of consumption after an expenditure shock. In particular, we show that models with endogenous entry can simultaneously generate an increase in consumption and firm entry in response to a positive government expenditure shock if entry has a very strong negative effect on markups, if labor supply is highly elastic, or if public consumption is utilityor productivity-enhancing. Model features that dampen the wealth effect, such as credit-constrained consumers or GHH preferences, instead tend to reduce entry as well as consumption. JEL classification: E21, E32, E62