The neoclassical model can easily accommodate an
increase in GDP following a government spending shock: as government spending increases in present discounted value terms, from the government’s intertemporal budget constraint taxation must increase by the same amount, and private wealth falls accordingly.
This negative wealth effect causes labor supply to shift out, and output and employment to increase. However, the same negative wealth effect implies that private consumption must fall. For the same reason, private investment increases if the shock is sufficiently
persistent.