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This paper extends the relative wealth specification of status preference to the two-sector Uzawa (1965)–Lucas (1988) model and examines the effectiveness of government spending on economic growth. It is found that the desire for relative wealth-induced social status and/or the education component of relative wealth-induced social status are important ingredients in determining the growth rate effects of government spending. Provided that the agent is concerned with his or her relative social position, the education-induced social status plays a more important role than the physical-asset-induced social status in determining the validity of public spending on growth. If individuals do not care about their education-driven social rewards, then an increase in government spending has no effect on the balanced growth rate regardless of the presence of the physical-asset-induced social status. A rise in government spending reduces the long-run growth rate if the education-induced social status is present.

The authors propose a pedagogical apparatus embodying a solid microfoundation with emphasis on the public's choice between currency and demand deposits being an optimal decision. On the basis of the pedagogical exposition, the authors explain how money supply is related to the combined behaviors of the central bank, commercial banks, and the public.