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IS GOVERNMENT SPENDING STIMULATIVE?
David Aschauer
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Is G o v e r n m e n t S p e n d i n g S t i m u l a t i v e ?
David Alan Aschauer
In analyzing the effects of fiscal policy on the economy, traditional macroeconomic models stress that the choice between debt and tax financing of
government spending m a y have distinctively different implications for con
sumption, investment, interest rates, a nd output. B o n d financed expendi
ture typically is taken to be m o r e stimulative than tax financed expenditure
since individuals d o not fully discount the future taxes implicit in b o n d is
suance a n d as a consequence d o not sufficiently reduce spending on con
sumer goods an d services.
T h e newclassical approach to fiscal policy, o n the other hand, emphasizes
the role which operative intergenerational transfers m a y play in overturning
this proposition.
Barro (1974) establishes conditions under which the
m e t h o d by which government spending is financed is of n o importance to
the real economy. O n this approach, altruistic individuals recognize that
the taxes underlying any current public debt creation will be levied on
subsequent m e m b e r s of their family line. Consequently, any shift from tax
to b o n d financing of government spending is completely internalized by
households, with the result of increased private savings and no additional
effect o n consumption expenditure or aggregate demand.
This “Ricardian” equivalence between b o n d and tax financing of a given
public expenditure stream has been the subject of extensive empirical re
search. Boskin (1987), Feldstein (1982), Modigliani a n d Sterling (1986),
and Poterba and S u m m e r s (1987), a m o n g others, offer evidence that con
sumption expenditure is affected by the m e t h o d of government finance.
However, Aschauer (1985), Barro (1978), Kochin (1974), K o r m e n d i (1982),
Seater (1982), Seater an d M a r i a n o (1985), and Tanner (1978, 1979) provide
offsetting results. Other authors, such as D w y e r (1982), Evans (1985, 1986,
1987), and Plosser (1982, 1987) have found either no statistical association
between public sector deficits and interest rates or a negative one, while
Hoelscher (1987) captures a positive relationship between government b o n d
issuance and long term interest rates. Aschauer (1988), Barro (1988), and
Bernheim (1987) provide useful surveys of the empirical evidence. A n o b
jective reading of the research in this area would appear to yield the con
clusion that the evidence is decidedly mixed on the basis of consumption
studies, while in slight favor to the equivalence proposition on the basis of
interest rate investigations.
O f course, granting the validity of the Ricardian theorem does not imply
that fiscal policy has no impact on the economy.
FRB CH ICAGO Staff M em orandum
Clearly, taxes of the
1
non- l u m p s u m variety generally will alter the incentives to c o n s u m e and
produce particular goods at particular points in time. Also, as emphasized
earlier by Bailey (1971), the effects which government spending will have
o n macroeconomic variables depend u p o n the precise characteristics of the
public expenditure being undertaken.
A h m e d (1987) and Barro (1981,
1987), for instance, differentiate between transitory and permanent changes
in goverment spending an d trace out their effects on output, interest rates,
a n d the trade balance.
Along
this line of reasoning,
temporary
surges
in goverment
spending— typically associated with wartime— create an excess d e m a n d for
goods an d services, induce up w a r d interest rate pressures, and result in ei
ther an increase in domestic production or a trade deficit. In contrast, a
permanent rise in government expenditure promotes an equal degree of re
source scarcity across time periods and has little or no effect o n interest
rates. Furthermore, as a permanent rise in government spending w ould be
m o r e likely to be associated with an increase in marginal tax rates— and
greater disincentives to engage in the market activities of e m p l o y m e n t and
production— output would be expected to rise by less than in the face of an
equal sized transitory increase in public spending.
This paper takes a different tack and investigates the extent to which public
consumption an d investment spending have diffferential impacts o n the
level of gross national product. T h e empirical results indicate that distin
guishing between government spending on current and capital accounts
m a y be of fundamental importance to the proper assessment of the potency
of government spending shocks to the economy. Specifically, public net
investment in infrastructure capital— highways, port facilities, dams, sewers,
etc— turns out to have a dramatically larger impact on output than does
military investment or public consumption expenditure.
I. Theoretical C o n c e r n s
T h e theoretical issues involved in differentiating between public c o n s u m p
tion an d investment expenditure and their consequent impact o n output
have been investigated elsewhere and are only discussed briefly here.1 For
detail, the reader is referred to Aschauer and G r e e n w o o d (1985). T h e
government is assumed to spend o n current and capital accounts in the
a m o u n t gc a nd gi, respectively. Expenditures on current account provide
consumption services (e.g. school lunches) as well as productive services
(e.g. police and fire protection). Let the marginal rate of substitution be
tween private consumption and public consumption services be denoted as
ugc and the marginal productivity of government services be given as f gc.
G o v e r n m e n t spending on capital account— additions to the public capital
stock— similarly m a y provide a flow of consumption services and pro
FRB CH ICAG O Staff M em orandum
2
duction services. For instance, the stock of public highways m a y comple
m e n t automobiles in producing vacations and simultaneously be
functioning as an input in the production of private sector output. Define
the marginal rate of substitution between private consumption and the
service flow derived from public capital as ugi and the marginal productivity
of public capital as f gi.
Specify the level of aggregate d e m a n d for goods and services as
y d = c(r,gc,gi,...) + i(r,g i,...) + gc + g i
where y d
=
aggregate d e m a n d for goods and services, c =
(1)
private con
sumption expenditure, i = private investment, gc = government spending
o n non-durable goods and services, gi = government investment, and r =
real interest rate. In the neoclassical model, both private consumption and
investment respond negatively to higher real interest rates.
increase
in
government
spending
on
consumption
A permanent
goods
and
services— holding fixed distortional taxes— will raise or lower private con
sumption expenditure depending u p o n the extent to which the goods pro
vided by the public sector act as complements or substitutes to private
consumption goods and they affect the level of effective wealth.2 T h e i m
pact on effective wealth, in turn, is proportional to the term (ugc + f gc — 1);
hence, effective wealth will fall with an increase in government spending
on current services if, on the margin, the s u m of the utility and production
services is less than the private consumption opportunities foregone. For
example, if private and public consumption goods were perfect substitutes
an d the goods played no role in private production (ugc — 1, f gc = 0) then
a permanent rise in government spending on such goods would have no
effect on the level of effective wealth and private consumption would fall
one-to-one with the rise in government spending. Aggregate d e m a n d then
would be left unaffected. In general, however, the effect on private con
sumption to a first approximation will be given by the term
(m pclr)*(ugc + f gc — 1) — ugcj where m p c = marginal propensity to c o nsume
out of wealth. Consequently, aggregate d e m a n d rises with an increase in
government spending if the marginal value of government services in all
uses is less than unity. A temporary increase in government spending on
consumption goods— defined to be a rise inducing no change in the present
value of government spending— will impact private consumption only to the
extent that private and public goods are substitutes or complements. For
example, in an intermediate case of less than perfect substitutability, private
consumption would decline in an a m o u n t proportional to ugn less than in
the instance of a permanent rise and its associated negative wealth effect
operating on consumption, so that aggregate d e m a n d would rise by an
a m o u n t directly related to (1 — ugc). Aschauer (1985) and K o r m e n d i (1983)
contain results for the United States indicating that, indeed, public ex
penditure on goods and services is less than perfectly substitutable for pri-
FRB CH ICAGO Staff M em orandum
3
vate sector spending.
A h m e d (1986) finds similar effects of public
consumption o n private consumption in the United K i n g d o m and, in a d
dition, that the marginal productivity of public services is sufficiently low
as to yield the inequality ugc + f gc < l.3 W e take these results as a m a i n
tained hypothesis in the subsequent discussion; consequently, the net effect
on aggregate d e m a n d of a rise in government spending o n consumption
goods an d services will not be as large as the rise in government spending
itself, regardless of whether the change in public purchases is of a transitory
or persistent character.
Public investment potentially can affect private consumption along various
channels as well. In particular, net public investment will impinge o n ef
fective wealth to the extent that there has previously been an over or
under-accumulation of public capital. Given that the marginal product of
public capital plus the marginal rate of substitution between the flow of
services from public capital lies above the marginal product of private
capital, f gi + u gi > f K an increase in public net investment will raise effective
wealth a nd thereby promote an increase in private consumption expendi
ture in an a m o u n t roughly equal to (m pt'lr)*(fgi + u gi —f ) per unit of net
public investment.
A m o r e central argument of this paper, however, is that public an d private
capital can be expected to be complementary inputs to the process go v
erning the production of private goods and services. Specifically, a rise in
government investment— given current capital stocks— m a y raise the m a r
ginal productivity of private capital and, in turn, stimulate higher private
investment expenditure. This, coupled with the previously described effects
o n consumption an d the likelihood that public capital spending will be
transitory in nature, suggests that public investment expenditure m a y have
significant positive effects on the level of aggregate demand.
T h e level of output supplied m a y be expressed as
/
= y (r,g c ,g i,...).
(2)
Here, higher real interest rates stimulate output along intertemporal sub
stitution lines by raising the future value of current productive activity.
Also, to the extent that government consumption expenditures lower effec
tive wealth, higher government spending will raise the level of output in an
a m o u n t equal to (fn*fn p c llr)*(u gc + f gc -1) per unit of spending, where f n =
marginal product of labor and mpcl = marginal propensity to c o n s u m e
leisure out of wealth. Finally, higher govenment spending o n current ser
vices will have a direct effect on output equal to f gc, yielding a total effect
o n output of (f* m p d lr )* ( u gc + f gc-1) + f gc per unit increase in such g o v
ernment spending.
I'RB C H IC AG O Staff M em orandum
4
Public investment spending similarly will impact o n the level of output
along a wealth channel. Specifically, a rise in public investment will induce
an e m p l o y m e n t response depending o n the sign of f —f gi —ugi; if the public
capital stock is “too low”— so f < f gi + ugi — the increase in the level of
public capital accumulation will raise wealth a n d lower the supply of labor
services in an a m o u n t equal to (m p c lfr)*^ —f gi —ugl).
Equilibrium in the goods market results in the expression
y
(3)
where the hypotheses of interest involve the magnitude of the response of
output to a rise in public consumption an d public investment spending, re
spectively. T h e framework of the neoclassical m odel implies that a rise in
government spending o n consumption goods a n d services will induce less
than a unitary response of output. For example, in the case of a persistent
rise in public consumption expenditure, the m a x i m u m impact o n output
will be given by 1 — ugc < 1; taking into account the effect the induced rise
in interest rates has on aggregate d e m a n d as well as distortional taxation
further attenuates the potency of such a rise in government spending. O n
the other hand, the impact o n output of a rise in public investment spending
is given by a *{ft - ugi + f gi) + b *(figi - f ti) 9 where f igi and f u represent the ef
fect of higher public and private capital, respectively, o n the marginal
product of private capital. Here a and b represent positive constants. T h e
first term in this expression relates output to any impact which higher
public capital accumulation m a y have on wealth. If the public capital stock
is at a deficient level, higher government capital formation will raise wealth
and lower w o r k effort while raising desired consumption. T h e induced ex
cess d e m a n d for output raises interest rates and, in equilibrium, lowers the
level of output. Aschauer (1987b) attempts to determine the extent to
which the public capital stock has deviated from its optimal level. A l
though the point estimates therein suggest the possibility that the public
capital stock m a y be too low, it is not possible to reject the hypothesis that
a rise in public investment will not have any marginal effect o n the level
of wealth of the representative agent in the economy. T h e second term
indicates the effect which public capital accumulation will have o n output
provided such capital is not a perfect substitute for its private sector
counterpart. In the case of infrastructure capital w e posit that f Lgi > 0 while
f u < 0, so a rise in public investment potentially will have very strong pos
itive effects on the evolution of private sector output.
FRB CH ICAG O Staff M em orandum
5
II. Empirical Analysis
T h e empirical analysis centers on the period 1949 to 1985 a nd utilizes a n
nual data. Aside from the data obtained from the N atio n al Income and
Product Accounts , the paper also employs data on public net investment as
published in F ix ed Reproducible Tangible Wealth in the United States. T h e
analysis relates gross national product to various public expenditure vari
ables, the public sector deficit, and the growth rate of the monetary base.4
5 T h e government spending variable is c o m p o s e d of total expenditures on
goods and services by all levels of government. T h e public net investment
series is co m p u t e d along perpetual inventory lines by subtracting c u m u l a
tive depreciation from the gross capital stock— cumulative gross investment
minus discards— so as to obtain the net capital stock. Depreciation of this
form of capital to derive a net capital stock series is achieved by c o m p a r
isons with similar types of private capital, data from governmental agencies
o n actual service lives, and on the assumptions m a d e by Goldsmith in a
background study o n corporate stock ownership by institutional investors.
T h e government capital accumulation series consists of federal, state, and
local net expenditures on equipment and structures and includes spending
o n military items, highways, sewers, dams, educational structures, and
other major public works projects. G o v e r n m e n t consumption is determined
residually by subtracting public net investment from total expenditures on
goods and services. A s such, government consumption includes expendi
tures for the purpose of replacing depreciated or discarded public capital.
A s discussed by Granger and N e w b o l d (1974). Nelson and K a n g (1984),
an d Nelson and Plosser (1981), in any study concerning the level of real
output and associated time series it is necessary to take proper account of
the likely nonstationarity of the data so as to avoid possible spurious cor
relations. T h e usual procedure is to first difference the data to achieve this
end and thereby to focus o n high frequency relationships in the sample. In
the current study, a different procedure is followed to address the problem
of nonstationarity. Specifically, the variables of particular interest are ex
pressed relative to the private net capital stock. T h e rationale is that this
specification will allow the analysis to pick up local trend relationships be
tween public spending and output which the process of first differencing
quite possibly would eliminate.
T h e regression of the output-capital ratio on a constant, time, and a lagged
value of itself yields the results
FRB CH ICAG O Staff M em orandum
6
y
= .41 - .002time + .71y(-l)
(.16) (.001)
(.11)
r-squared = .87
s.e.r. = .031
log-likelihood = 77.86
s.s.r. = .032
T h e output-capital ratio will be difference stationary if the coefficient on
time is insignificantly different from zero and the coefficient on the lagged
value of the output-capital ratio is insignificantly different from unity. If,
instead, the coefficient value on the lagged value of the output-capital ratio
is significantly less than unity, the output-capital ratio is trend stationary.
T h e t-ratio for the purpose of testing the null hypothesis that the coefficient
o n y(-l) equals unity is c o m p u t e d as 2.64. For small samples, the least
squares estimate of y(-l) is not distributed about unity but rather a smaller
value. Dickey and Fuller (1979) present correct empirical distributions for
the estimators of the above specification. For a sample size of 25, a t-ratio
of 2.16 implies a 99 percent probability that the coefficient on y(-l) is less
than unity. Thus, w e m a y reject difference stationarity in favor of trend
stationarity for the output-capital ratio.
Is G o v e r n m e n t Spending Expansionary?
Consider n o w the regression of the output ratio on the level of total gov
ernment expenditures o n goods and services, relative to the private net
capital stock, and the rate of growth of the monetary base. W e obtain
y =
1.09 - .005time + .87g + .54dm
(.08) (.001)
(.17)
(.18)
r-squared = .887
s.e.r. = .026
d-w = 1.24
log-likelihood = 81.68
s.s.r. = .026
Here, an increase in government spending has a significant, positive impact
o n the level of output, and the point estimate lies quantitatively, though
not significantly, below unity.
This result is in h a r m o n y with the
neoclassical model and is consistent with the less than unitary response of
output to temporary and permanent government spending results of Barro
(1981).6 A n increase in the m o n e y base growth rate also induces a statis
tically important increase in the level of output. This, too, can be inter
preted as being consistent with an
FRB CH ICAGO Staff M em orandum
equilibrium model
due
to either
7
informational discrepancies or deviations from superneutrality, at least on
the transition path between steady-states.7 Note, however, that the value
of the Durbin-Watson statistic lies in the inconclusive range of the test for
serial correlation in the residuals. Reestimating the equation with a first
order autocorrelation correction allows the result
y =
1.25 - .006time + .51g + .55dm
(.15) (.002)
(.30)
(.18)
rho = .55 (.16)
r-squared = .911
s.e.r. = .025
log-likelihood = 83.86
s.s.r. = .020
Thus, w e still find a significant relationship between the overall level of
government expenditure o n goods a nd services and the level of output,
though only at the 1 0 % level. Further, the 9 5 % confidence interval for the
coefficient o n government spending allows for a multiplier as large as 1.1,
s o m e w h a t larger than the value of unity as suggested by neoclassical theory.
However, the discussion above indicated that it m a y be inappropriate to
assess the impact of government spending o n the e c o n o m y without taking
consideration of the possible differential effects of government consumption
and investment spending. Table I contains estimates of the effect of go v
ernment consumption, military investment, and non-military investment on
the output ratio. Here, government consumption is defined residually by
subtracting from total government spending on goods a n d services public
net investment, where the latter has been categorized into military and
non-military components. T h e equations contained in Table I indicate that
for the period 1949 to 1985 non-military public net investmentinfrastructure investment— has had the most importance in influencing the
level of output, while military investment and public consumption have had
quantitatively m inor a nd statistically insignificant effects o n gross national
product.
Indeed, in all the equations, a rise in the level of public
infrastructure investment of one dollar is associated with a rise in the level
of output of approximately four dollars.
It might be claimed that a partial reason for this high positive association
of output with productive public investment is due to the fact that both
variables are expressed relative to a c o m m o n variable, the private net cap
ital stock. This argument m a y be addressed by estimation by two stage
least squares, using the level of public net non-military investment relative
to the public net capital stock as an instrument. This results in
FRB CH IC A G O Staff M em orandum
8
Table I
D ep endent variab le is g ro ss national p ro d u ct
relative to th e net p rivate cap ital sto ck
(both in 1982 do llars)
(D
OLS
(2)
FOAC
(3)
OLS
(4)
FOAC
const
1.22
(1 4 )
.121
(.16)
1.30
(.04)
time
-.0 0 5
(.001)
-.0 0 5
(0 0 1 )
ignm
3.80
(.88)
igm
(5)
OLS
(6)
FOAC
1.28
(.06)
1.28
(.03)
1.29
(.06)
-.0 0 6
(0 0 1 )
-.0 0 5
(.001)
-.0 0 6
(.001)
-.0 0 6
(.001)
3.72
(1.47)
4.10
(.70)
4.20
(1.13)
4.37
(.65)
4.11
(1.10)
.34
(.53)
.21
(1.30)
.48
(.46)
.66
(.98)
gc
.22
(.38)
.24
(4 9 )
dm
.58
(.17)
.49
(.18)
.62
(1 5 )
.48
(1 6 )
.35
(.19)
-
.37
(.19)
rho
-
-
-
_
-
.63
(.15)
.50
(1 6 )
.35
(.18)
-
const
1.22
(.14)
.121
(.16)
1.30
(0 4 )
1.28
(.06)
1.28
(-03)
1.29
(.06)
time
-.0 0 5
(.001)
-.0 0 5
(.001)
-.0 0 6
(.001)
-.0 0 5
(0 0 1 )
-.0 0 6
(0 0 1 )
-.0 0 6
(0 0 1 )
ignm
3.80
(.88)
3.72
(1.47)
4.10
(.70)
4.20
(1.13)
4.37
(.65)
4.11
(1.10)
igm
.34
(.53)
.21
(1.30)
.48
(.46)
.66
(.98)
gc
.22
(.38)
.24
(.49)
-
-
-
-
-
dm
.58
.49
.62
.48
.63
.50
r-sq
.914
.919
.915
.921
.915
.923
s.e.r.
.025
.024
.024
.024
.024
.024
d-w
s.s.r.
1.40
.019
.017
1.38
.019
.017
1.36
.020
.017
standard errors in parentheses,
y = real gross national product
ignm = non-military net public investment in equipment and structures
igm = military net investment in equipment and structures
gc = public consumption expenditures; all relative to the private net capital stock,
dm = percentage growth rate of monetary base.
FRB CH ICAGO Staff M em orandum
9
y — 1.28 - .006time + 4.43ignm + .63dm
(.03)(.001)
(.65)
(.15)
r-squared = .915
s.e.r. = .024
d-w = 1.36
log-likelihood = 87.04
s.s.r. = .020
and, with a first order autocorrelation correction,
y =
1.29 - .006time + 4.07ignm + .50dm
(.06)(.001)
(1.12)
(.16)
rho = .35 (.18)
r-squared = .923
s.e.r. = .024
log-likelihood = 86.48
s.s.r. = .017
Thus, the only change in the estimated equations is to be found in the co
efficients of the public investment variable and such changes are statistically
negligible.
Lucas (1976) called attention to the perils of assuming the coefficients of a
reduced form expression to be invariant to changes in the underlying policy
process. In the present case the forcefulness of this argument is diminished,
at least relative to monetary applications, as the relationship between public
capital accumulation and output depends u p o n channels which would be
operative even if changes in government investment policy were prean
nounced. Still, it is of interest to determine whether or not the relationship
between public investment spending and the level of output exhibits stabil
ity throughout the sample period. Estimating the last equation for the two
subperiods from 1949 to 1967 and 1968 to 1985 leads to the results
1949-67:
y =
1.31 - .009time + 7.31ignm + .82dm
(.03) (.001)
(1.64)
(.16)
r-squared = .826
s.e.r. = .013
d- w = 1.87
s.s.r. = .006
FRB CH ICAGO Staff M em orandum
10
1968-85:
y =
1.03 - .001 time + 6.65igrm 4- .46dm
(2.41)
(.32)
(.20) (.003)
r-squared = .826
s.e.r. = .016
d-w = 1.69
s.s.r = .009
T h e statistic relevant for testing the hypothesis of coefficient stability has
an F-distribution with (4,28) degrees of freedom. T h e value of the statistic
is 2.28, below the 95 percent critical point of the distribution, which is 2.71.
Thus, w e d o not reject the hypothesis of stability, although it is informative
to note that for both subsamples the estimated coefficient on the public net
investment variable has increased by a large amount. However, given the
size of the standard errors of the coefficient estimate, it is not possible to
confidently reject the hypothesis that the coefficient equals the value o b
tained earlier from the full sample regressions.
A s further evidence of the robustness of these results, consider the following
regressions o n subsamples obtained by deleting the first and last four years
of the full sample period. This eliminates, in turn, the influence of both the
immediate post-World W a r II period (1949-52) and of the most recent pe
riod of extremely low public investment (1982-85). W e have
1953-85
y =
1.22 - .004time + 5.19ignm + .51dm
(.06) (.001)
(.97)
(.20)
r-squared = .91
s.e.r = .024
d-w = 1.34
s.s.r. = .017
1949-81
y =
1.30 - .006time + 4.24ignm + .72dm
(.03) (.001)
(.63)
(.15)
r-squared = .897
s.e.r. = .023
d-w = 1.43
s.s.r. = .015
FRB CHICAGO Staff M em orandum
11
T h e results thus d o not appear to be dependent u p o n the particular sample
chosen for the purpose of estimation, although there is s o m e evidence of a
larger effect of government net investment o n the level of output for the
period beginning in 1953.
A r e G o v e r n m e n t Deficits Important?
W e n o w investigate the effect of public sector deficits, as measured by the
National Inco m e an d Product Accounts, o n the level of output. Table II
contains the regressions relevant to the question of whether or not the
m e t h o d of financing public expenditure has any importance for output
given the effects of public investment an d m o n e y growth. Consider first the
ordinary least squares results which indicate a statistically significant nega
tive relationship between the level of output a n d the government deficit.
While not consistent with standard analyses of the effects of public sector
deficits, this result that deficits are contractionary has theoretical support
in w o r k by Aschauer (1987a), Blanchard (1984), Feldstein (1984), a n d
M a n k i w an d S u m m e r s (1987).8 Apparently, correcting for serial correlation
in the residuals only strengthens this effect.
O f course, the deficit bears a countercyclical relationship to output, largely
due to the procyclicality of tax revenues.9 T o take account of the implied
simultaneity bias, equations (3) and (4) were run employing two stage least
squares, with military net investment and government consumption relative
to the private capital stock taken as instruments. While leaving the strong
positive effect of public non-military investment virtually unaltered, the
coefficient o n the deficit variable changes sign but is statistically insignif
icant in both equations. E v e n taking the point estimates in the latter cases
as valid, however, it is clear that public investment has the larger effect on
the level of output.
W e m a y also take account of the countercyclicality of the budget deficit by
utilizing a series o n the high-employment budget deficit. Such a series for
the federal deficit is available for the period 1955 to 1985 a nd is to be found
in Holloway (1986). Equations (5) through (8) contain estimates of the ef
fects of public net investment and the cyclically-adjusted budget deficit o n
the output-capital ratio. T h e introduction of this variable, expressed rela
tive to the net private capital stock, has two important effects o n the fitted
equations. First, the magnitude of the relationship between the public in
vestment variable and output is enhanced, with the public capital a c c u m u
lation multiplier n o w lying in the range of six to eight. However, this is to
a large extent due to the elimination of the first seven sample points, as the
coefficient on the public investment variable in a regression excluding the
high e m p l o y m e n t budget deficit variable equals 5.87 (.96) and 6.41 (1.18)
for the ordinary least squares a nd first-order autocorrelation correction es-
I RB CH IC A G O Staff M em orandum
12
Table II
D ependent va riab le is g ro ss national pro duct
relative to net private cap ital sto ck
(in 1982 d o llars)
(4)
TSLS/FOAC
(5)
OLS
(6)
FOAC
(D
OLS
(2)
FOAC
(3)
TSLS
const
1.26
(.03)
.124
(.07)
1.29
(.04)
1.27
(.07)
1.11
(.09)
1.03
(.10)
time
-.0 0 5
(0 0 1 )
-.0 0 4
(.001)
-.0 0 6
(.001)
-.0 0 5
(.001)
-.0 0 2
(.002)
-.0 01
(.002)
ignm
4.41
(.61)
4.56
(1.34)
4.34
(.77)
4.29
(1.21)
6.40
(1.18)
7.22
(1.38)
def
- .6 3
(.27)
-.8 5
(.23)
.55
(.62)
-.4 3
(.37)
'
-
(7)
OLS
(8)
FOAC
1.00
(.01)
1.00
(.02)
-
-
7.64
(.54)
7.58
(.70)
-
-
-
_
_
-
-
- .4 2
(.53)
-.6 2
(.51)
-.9 1
(.34)
- .7 3
(.38)
dm
.52
(-15)
.37
(.13)
.73
(.21)
.42
(.15)
.37
(.21)
.31
(.20)
.21
(.16)
.27
(.17)
rho
_
.55
(.17)
-
.47
(.18)
-
.32
(.19)
hdef
.34
(.18)
-
r-sq
.925
.943
.881
.937
.914
.924
.912
.927
s.e.r.
.023
.020
.029
.021
.023
.021
.023
.021
d-w
s.s.r.
1.02
.017
.012
1.60
.027
.014
1.29
.014
.014
1.19
.015
.011
standard errors in parentheses.
def = National Income and Product Accounts total public sector deficit
hdef = cyclically-adjusted federal budget deficit; both deflated by the implicit deflator for gross national product
and expressed relative to the net private capital stock.
timates, respectively (standard errors in parentheses). Second, the coeffi
cient on the trend variable, although still negative, is not statistically
different from zero. Elimination of the time variable from the regression
then allows the coefficient on the high em p l o y m e n t deficit to attain statis
tical importance in explaining the evolution of output, but the estimated
relationship indicates a negative association between the deficit an d output,
just as in the ordinary least squares estimation employing the unadjusted
total government budget deficit. Clearly, public net investment appears to
have m o r e importance in explaining output than does the size of the public
sector deficit, whether the latter is or is not adjusted to take account of
automatic effects associated with the business cycle.
FRB CH ICAGO Staff M em orandum
13
III. Conclusion
This paper has investigated the implication of distinguishing between public
consumption an d public net investment— on non-military an d military
equipment and structures, respectively— for a proper assessment of the i m
portance of fiscal policy to the level of output. Briefly, while military in
vestment an d public consumption are of little statistical importance to gross
national product, net public investment in infrastructure capital has a
strong positive effect o n the level of output. T h e channel by which public
net investment o n non-military items is expected to have such an
expansionary effect o n output is through a structural complementary re
lationship between private and public net capital stocks in the private pro
duction process. Specifically, a rise in public capital accumulation enhances
the productivity of private capital which, in turn, stimulates additional
private capital investment. Aschauer (1987c) offers supporting evidence by
isolating a strong positive association between the public non-military cap
ital stock and the rate of return to non-financial corporate capital, the latter
being measured as the ratio of corporate profits plus net interest (as a re
turn to debt holders) to the replacement value of fixed nonresidential capi
tal, land, and inventories.
Further, given the level of public investment, neither the National Income
a n d Product Accounts budget deficit nor a version adjusted for cyclical ef
fects exhibits the positive association with output claimed by conventional
macroeconomic models. Thus, in determining the effects of fiscal spending
an d revenue plans o n the economy, the results of this paper suggest that
m o r e attention should be focused o n the type of expenditure being a dv o
cated and less on the m e t h o d by which such spending is to be financed,
whether by debt or taxes.
FRB CH ICAG O Staff M em orandum
14
1 The underlying model assumes an infinite planning horizon, a constant returns
to scale production technology, and competitive conditions in factor and product
markets.
2 Effective wealth is defined as the economy-wide level of wealth, obtained by
consolidating private and public sector budget constraints. In the present context
it may be written as
k0
+
^ ^ R t( w t
+
(u gc + f gc —
l)g c (
+
(fg i
+
U gi — r t) g k t_ i
)
t
where k t = national (private plus public) capital stock during period
/ + 1, R t = ((1 + r1)(l + r2)...(l + r,))-1, w t = real wage in period t, and g k r =
public capital stock during period t +1.
3 More exactly, Ahmed (1986), Aschauer (1985), and Kormendi (1983) obtain
point estimates for u gc in the range (.2, .4) while Ahmed (1986) finds a value of
f g c of .39.
4 Results involving net as opposed to gross national product were insufficiently
distinguishable from those of the paper to warrant reporting.
5 This paper does not differentiate between expected and unexpected money
growth but rather focuses on the effects of various fiscal policies. Mishkin (1983)
contains results which indicate a significant expansionary role for expected money,
although less than that of unexpected money. Blanchard (1987) is a thoughtful
survey of these and related issues.
6 Barro (1981) isolated a greater expansionary effect of temporary than of per
manent changes in military spending. Permanent changes in non-military pur
chases were found to be insignificantly different than zero. Note that Barro’s
empirical specification involved regressing the natural logarithm of real output
on various government spending variables exressed relative to gross output.
7 See, for example, Fischer (1979), where higher money growth is associated with
faster rates of capital accumulation in the optimizing model of Sidrauski (1967),
at least for preferences in the constant relative risk aversion class.
8 Aschauer (1987a) argues in an optimizing framework with time separable pref
erences that to the extent government debt issuance increases perceived wealth,
desired work effort will decrease, reducing the level of output in equilibrium.
Blanchard (1984) provides a model such that in an environment of slowly in
creasing deficits over time, real interest rates on long bonds rise, thereby de
pressing investment and output. Feldstein presents a two sector model in which
a negative fiscal deficit multiplier becomes possible through induced changes in
the sectoral balance of demand. Mankiw and Summers (1987) offer the idea that
an appropriate scale variable in money demand is aggregate consumption and not
real output; consequently, it becomes possible for a tax cut to be contractionary
if the effect on output due to the excess demand for goods is dominated by the
effect due to an increased demand for money.
9 See, for example, Firestone (1960).
FRB CHICAGO Staff M em orandum
15
D a t a Sources
The private and public capital stock series are mid-year arithmetic averages of the
end-of-year net stocks published in Fixed Reproducible Tangible Wealth in the
United States 1925-85. The private net stock is composed of fixed nonresidential
capital in billions of 1982 dollars (Table 8, column 1). The public net stocks are
of non-military and military capital, also in billions of 1982 dollars (Table 16,
columns 1 and 4). The public investment flows are the changes in the end-of-year
stocks. Government consumption expenditure is derived by subtracting public
net investment from total government expenditure on goods and services, the
latter being obtained from the Economic Report of the President. The monetary
base is from the Federal Reserve Bulletin. The N I P A deficit is converted to a real
magnitude using the deflator for gross national product, both obtained from the
Economic Report of the President.
The cyclically adjusted deficit is from
Holloway (1986).
FRB C H IC AG O Staff M em orandum
16
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