Abstract

This article examines the quantitative interrelations between sectoral composition of public spending and equilibrium determinacy in a two-sector real business cycle model with positive productive externalities in investment. When government purchases of consumption and investment goods are set as constant fractions of their respective sectoral output, we show that the public-consumption share plays no role in the model's local dynamics, and that a sufficiently high public-investment share can stabilize the economy against endogenous belief-driven cyclical fluctuations. When each type of government spending is postulated as a constant proportion of the economy's total output, we find that there exists a trade-off between public consumption versus investment expenditures to yield saddle-path stability and equilibrium uniqueness. © 2014 Western Economic Association International.