The implications of public expenditures on a small economy in transition: a Bayesian DSGE approach

Abstract

This paper explores the influence of government expenditures on the business cycle dynamics of a small transition country such as Vietnam. We develop a comprehensive stochastic-growth DSGE model where government consumption may affect households’ utility function, and there is habit persistence in consumption and endogenous private capital utilisation. Two fiscal shocks are considered in addition to shocks to households’ preferences and technological progress. The estimated DSGE model adequately captures the dynamics of Vietnam’s economy and is helpful to uncover a diversity of findings. First, public investment was an important driver of Vietnam’s high output growth in the early-to-mid 1990s, although its contribution decreased during the 2000s. Second, government expenditures explain, respectively, up to 30% and 20% of Vietnamese output variations in the long and short run. Third, impulse–response functions reveal a 3% GDP cumulative 5-year gain from a public investment shock of 1% GDP. Fourth, simulation analysis of different fiscal policies unveils a significant and positive impact of productive public investment by crowding in private investment.