Does the Crowding-In Effect of Public Spending on Private Consumption Undermine Neoclassical Models? Steve Ambler * Hafedh Bouakez † Emanuela Cardia ‡ February 2010 Abstract Recent empirical evidence from vector autoregressions suggesting that public spending shocks crowd in private consumption has been judged para- doxical in the light of neoclassical models of the business cycle. We show that a standard real business cycle model in all agents including the govern- ment optimize is compatible with crowding in. The model generates positive comovement between public spending and private consumption, regardless of whether private and public purchases are complements or substitutes. JEL classification: E2, E3, H3 Keywords: Optimal public spending, Business cycles, Crowding in * Corresponding author. CIRP ´ EE and D´ epartement des sciences ´ economiques, Universit´ e du Qu´ ebec ` a Montr´ eal, C.P. 8888, Succ. Centre-ville, Montr´ eal, QC, Canada H3C 3P8, email am- bler.steven@uqam.ca, phone 514-987-3000 ext. 8372 † Institute of Applied Economics and CIRP ´ EE, HEC Montr´ eal, 3000 chemin de la C ˆ ote-Sainte- Catherine, Montr´ eal, QC, Canada H3T 2A7. ‡ CIREQ and D´ epartement de sciences ´ economiques, Universit´ e de Montr´ eal, C.P. 6128, Succ. Centre-ville, Montr´ eal, QC, Canada H3C 3J7.