Government Spending and Private Activity

April 2, 2012

A new paper from the National Bureau of Economic Research asks whether increases in government spending stimulate private activity.

The first part of the paper studies private spending.

  • Using a variety of identification methods and samples, the author finds that in most cases private spending falls significantly in response to an increase in government spending.
  • These results imply that the average gross domestic product (GDP) multiplier lies below unity.
  • Unity is equal to one, thus, if the average multiplier is, say, 0.5, a 1 percent increase in government spending only increases GDP growth by half a percent.
  • In order to determine whether concurrent increases in tax rates dampen the spending multiplier, the author uses two different methods to adjust for tax effects.
  • Neither method suggests significant effects of current tax rate changes on the spending multiplier.

In the second part of the paper, the author explores the effects of government spending on labor markets.

  • The author finds that increases in government spending lower unemployment.
  • Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment.

The author concludes that on balance government spending does not appear to stimulate private activity.

Source: Valerie A. Ramey, "Government Spending and Private Activity," National Bureau of Economic Research, January 2012.

For text:

http://www.nber.org/papers/w17787  

 

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