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Chapter12 Government Expenditure
Macroeconomics - Barro Chapter 12
1
Data on Government Expenditure • Government expenditure is the dollar amount spent at all levels of government for purchases of goods and services, transfer payments (amounts given to households and businesses), and interest payments.
Macroeconomics - Barro Chapter 12
2
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
3
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
4
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
5
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
6
Macroeconomics - Barro Chapter 12
7
The Government’s Budget Constraint • Gt represent government purchases in real terms for year t. – Ct + It + Gt, is the aggregate real spending on goods and services in year t.
• Vt represent the government’s real expenditure on transfers. • The real value of this revenue for year t is (Mt −Mt−1)/Pt • Tt be the total real taxes collected by the government in year t. Macroeconomics - Barro Chapter 12
8
The Government’s Budget Constraint • Government budget constraint: – total uses of funds = total sources of funds – Gt + Vt = Tt + ( Mt− Mt−1)/ Pt – real purchases+ real transfers = real taxes+ real revenue from money creation Macroeconomics - Barro Chapter 12
9
The Government’s Budget Constraint • Government budget constraint – Gt + Vt = Tt
– real purchases+ real transfers= real taxes
Macroeconomics - Barro Chapter 12
10
Public Production • we are assuming that the government subcontracts all of its production to the private sector. • public investment, publicly owned capital, and government employment are zero.
Macroeconomics - Barro Chapter 12
11
Public Services • Begin with the hypothetical case in which public services have zero effect on utility and production.
Macroeconomics - Barro Chapter 12
12
The Household’s Budget Constraint • Household budget constraint – C + (1/P)·∆B+∆K = (w/P)·Ls+ i·( B/P+K) – Ct + (1/P)·∆Bt+∆Kt = (W/P)t·Lst + rt−1·( Bt−1/P + Kt−1)
• With Government – Ct + (1/P)·∆Bt+∆Kt = (W/P)t·Lst + rt−1·( Bt−1/P + Kt−1) +Vt − Tt
Macroeconomics - Barro Chapter 12
13
The Household’s Budget Constraint • Multiyear household budget constraint with transfers and taxes: • C1 + C2/(1+r1) + · · · = (1+r0)·( B0/P+K0) +(w/P)1·Ls1 +(w/P)2 · Ls2 /(1+r1) + ·· · +( V1 − T1) + ( V2 − T2)/( 1 + r1) +( V3 − T3)/[(1+ r1) · ( 1 + r2) ] + ·· ·
Macroeconomics - Barro Chapter 12
14
Permanent Changes in Government Purchases • Theory – G+ V = T or V − T = −G – G rises by one unit each year, V − T falls by one unit each year. – household’s disposable real income falls by one unit each year.
Macroeconomics - Barro Chapter 12
15
Permanent Changes in Government Purchases • Theory – Since the typical household has one less unit of real disposable income each year, we predict that the decrease in C each year will be roughly by one unit.
Macroeconomics - Barro Chapter 12
16
Permanent Changes in Government Purchases • Theory – how the increase in government purchases affects the demand and supply of capital services and real GDP. • an increase in government purchases, G, does not shift the curves for the demand or supply of capital services. – the market-clearing real rental price, (R/P)∗, and quantity of capital services, (κK)∗, do not change.
Macroeconomics - Barro Chapter 12
17
Permanent Changes in Government Purchases • Theory – We found that the quantity of capital services, κK, is unchanged, and we assumed that the technology level, A, and the quantity of labor input, L, are fixed. – Therefore, Y is unchanged. – Important conclusion that a permanent increase in government purchases does not affect real GDP. Macroeconomics - Barro Chapter 12
18
Permanent Changes in Government Purchases • Theory – r = ( R/ P) · κ − δ(κ) • a permanent increase in government purchases does not affect the real interest rate.
Macroeconomics - Barro Chapter 12
19
Permanent Changes in Government Purchases • Theory – G, does not shift labor supply, Ls, which is fixed at L, and does not shift the labordemand curve, Ld. • the market-clearing real wage rate, (w/P)∗, ∗ does not change. • We conclude that a permanent increase in government purchases does not affect the real wage rate.
Macroeconomics - Barro Chapter 12
20
Permanent Changes in Government Purchases • Theory – We know from our analysis of income effects that a permanent rise in government purchases, G, by one unit reduces C in each year by roughly one unit.
Macroeconomics - Barro Chapter 12
21
Permanent Changes in Government Purchases • Theory – The intertemporal-substitution effect depends on the real interest rate, r. Since r does not change, the ntertemporal-substitution effect does not operate. Another substitution effect involves consumption and leisure, butwe have assumed that the quantity of labor and, hence, the quantity of leisure, is fixed. In any event, this substitution effect depends on the real wage rate, w/P, which does not change Macroeconomics - Barro Chapter 12
22
Permanent Changes in Government Purchases • Theory – our prediction is that a permanent increase in government purchases by one unit causes consumption to decrease by about one unit.
Macroeconomics - Barro Chapter 12
23
Permanent Changes in Government Purchases • Theory – Y= C+ I + G • the changes in C and G fully offset each other and, thereby, allow I to remain unchanged.
Macroeconomics - Barro Chapter 12
24
Permanent Changes in Government Purchases • Theory – we predict that a permanent increase in government purchases, G, • Reduces consumption, C, roughly one to one. • The variables that do not change include real GDP, Y; gross investment, I; the quantity of capital services, κK; the real rental price, R/P; the real interest rate, r; and the real wage rate, w/P.
Macroeconomics - Barro Chapter 12
25
Permanent Changes in Government Purchases
Macroeconomics - Barro Chapter 12
26
Temporary Changes in Government Purchases • Theory – Assume now that year 1’s real government purchases, G1, rise by one unit, while those for other years, Gt, do not change. That is, everyone expects that Gt in future years will return to the original level.
Macroeconomics - Barro Chapter 12
27
Temporary Changes in Government Purchases • Theory – Vt− Tt= −Gt – Vt− Tt falls by one unit, and households have one unit less of real disposable income. In subsequent years, Vt − Tt and, hence, real disposable income return to their original levels.
Macroeconomics - Barro Chapter 12
28
Temporary Changes in Government Purchases • Theory – Households would spread their reduced disposable income in year 1 over reduced consumption, Ct, in all years t. Therefore, the effect on year 1’s consumption, C1, will be relatively small. The propensity to consume out of a temporary change in income is greater than zero but much less than one.
Macroeconomics - Barro Chapter 12
29
Temporary Changes in Government Purchases • Theory – Y= C+ I + G – Y, is unchanged; real government purchases, G, are higher in year 1 by one unit; and consumption, C, is lower, but by much less than one unit. Consequently, equation (12.9) implies that gross investment, I, must fall. Macroeconomics - Barro Chapter 12
30
Temporary Changes in Government Purchases • Theory – Since the decrease in C is relatively small, the decline in I is large. That is, year 1’s extra G comes mainly at the expense of I, rather than C. – When the change in G was permanent, we predicted that most or all of the extra G came at the expense of C.
Macroeconomics - Barro Chapter 12
31
Government Purchases and Real GDP During Wartime: Empirical • We test the model by studying the response of the economy to the temporary changes in government purchases that have accompanied U.S. wars.
Macroeconomics - Barro Chapter 12
32
Government Purchases and Real GDP During Wartime: Empirical
Macroeconomics - Barro Chapter 12
33
Government Purchases and Real GDP During Wartime: Empirical • The data also show that the rises in real GDP are by less than the increases in government purchases. That is, aside from military purchases, the totals of the other components of real GDP are down during wartime. The model accords with this pattern. However, the components of real GDP other than military purchases do not fall nearly as much as predicted by the model. Macroeconomics - Barro Chapter 12
34
Wartime Effects on the Economy • Employment during wartime – The basic pattern is that the military took in a significant number of persons total employment expanded a little more.
Macroeconomics - Barro Chapter 12
35
Wartime Effects on the Economy • Effects of war on labor supply – At this point, there is no settled view among economists about the best way to understand labor supply during wartime. • A large expansion of real government purchases, G, means that households have less real disposable income. • Casey Mulligan (1998) argues that labor supply, Ls, increases during wartime because of patriotism. • the military draft would affect the labor supply of single womenn.
Macroeconomics - Barro Chapter 12
36
Wartime Effects on the Economy
Macroeconomics - Barro Chapter 12
37
Wartime Effects on the Economy • Employment Effects on Labor Markets – Prediction that a war reduces the real wage rate, w/P
Macroeconomics - Barro Chapter 12
38
Wartime Effects on the Economy • Effects of war on the rental market – a wartime increase in labor supply, Ls, led to an increase in labor input, L. This change affects the rental market, because the rise in L tends to increase the MPK (for a given quantity of capital services, κK). • The demand curve shifts right because the higher quantity of labor, L, raises the MPK for a given quantity of capital
Macroeconomics - Barro Chapter 12
39
Wartime Effects on the Economy • Effects of war on the rental market – a wartime increase in labor supply, Ls, led to an increase in labor input, L. This change affects the rental market, because the rise in L tends to increase the MPK (for a given quantity of capital services, κK). • The demand curve shifts right because the higher quantity of labor, L, raises the MPK for a given quantity of capital
Macroeconomics - Barro Chapter 12
40
Wartime Effects on the Economy
Macroeconomics - Barro Chapter 12
41
Wartime Effects on the Economy • Effects of war on the rental market – For a given capital stock, K, the rise in κK corresponds to an increase in the capital utilization rate, κ. – r = ( R/ P) · κ − δ(κ) • increases in R/P and κ imply that r increases.
Macroeconomics - Barro Chapter 12
42
Wartime Effects on the Economy • Effects of war on the rental market – The predictions for higher real interest rates during wartime conflict with the U.S. data.
Macroeconomics - Barro Chapter 12
43
Macroeconomics - Barro Chapter 12
1
Data on Government Expenditure • Government expenditure is the dollar amount spent at all levels of government for purchases of goods and services, transfer payments (amounts given to households and businesses), and interest payments.
Macroeconomics - Barro Chapter 12
2
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
3
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
4
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
5
Data on Government Expenditure
Macroeconomics - Barro Chapter 12
6
Macroeconomics - Barro Chapter 12
7
The Government’s Budget Constraint • Gt represent government purchases in real terms for year t. – Ct + It + Gt, is the aggregate real spending on goods and services in year t.
• Vt represent the government’s real expenditure on transfers. • The real value of this revenue for year t is (Mt −Mt−1)/Pt • Tt be the total real taxes collected by the government in year t. Macroeconomics - Barro Chapter 12
8
The Government’s Budget Constraint • Government budget constraint: – total uses of funds = total sources of funds – Gt + Vt = Tt + ( Mt− Mt−1)/ Pt – real purchases+ real transfers = real taxes+ real revenue from money creation Macroeconomics - Barro Chapter 12
9
The Government’s Budget Constraint • Government budget constraint – Gt + Vt = Tt
– real purchases+ real transfers= real taxes
Macroeconomics - Barro Chapter 12
10
Public Production • we are assuming that the government subcontracts all of its production to the private sector. • public investment, publicly owned capital, and government employment are zero.
Macroeconomics - Barro Chapter 12
11
Public Services • Begin with the hypothetical case in which public services have zero effect on utility and production.
Macroeconomics - Barro Chapter 12
12
The Household’s Budget Constraint • Household budget constraint – C + (1/P)·∆B+∆K = (w/P)·Ls+ i·( B/P+K) – Ct + (1/P)·∆Bt+∆Kt = (W/P)t·Lst + rt−1·( Bt−1/P + Kt−1)
• With Government – Ct + (1/P)·∆Bt+∆Kt = (W/P)t·Lst + rt−1·( Bt−1/P + Kt−1) +Vt − Tt
Macroeconomics - Barro Chapter 12
13
The Household’s Budget Constraint • Multiyear household budget constraint with transfers and taxes: • C1 + C2/(1+r1) + · · · = (1+r0)·( B0/P+K0) +(w/P)1·Ls1 +(w/P)2 · Ls2 /(1+r1) + ·· · +( V1 − T1) + ( V2 − T2)/( 1 + r1) +( V3 − T3)/[(1+ r1) · ( 1 + r2) ] + ·· ·
Macroeconomics - Barro Chapter 12
14
Permanent Changes in Government Purchases • Theory – G+ V = T or V − T = −G – G rises by one unit each year, V − T falls by one unit each year. – household’s disposable real income falls by one unit each year.
Macroeconomics - Barro Chapter 12
15
Permanent Changes in Government Purchases • Theory – Since the typical household has one less unit of real disposable income each year, we predict that the decrease in C each year will be roughly by one unit.
Macroeconomics - Barro Chapter 12
16
Permanent Changes in Government Purchases • Theory – how the increase in government purchases affects the demand and supply of capital services and real GDP. • an increase in government purchases, G, does not shift the curves for the demand or supply of capital services. – the market-clearing real rental price, (R/P)∗, and quantity of capital services, (κK)∗, do not change.
Macroeconomics - Barro Chapter 12
17
Permanent Changes in Government Purchases • Theory – We found that the quantity of capital services, κK, is unchanged, and we assumed that the technology level, A, and the quantity of labor input, L, are fixed. – Therefore, Y is unchanged. – Important conclusion that a permanent increase in government purchases does not affect real GDP. Macroeconomics - Barro Chapter 12
18
Permanent Changes in Government Purchases • Theory – r = ( R/ P) · κ − δ(κ) • a permanent increase in government purchases does not affect the real interest rate.
Macroeconomics - Barro Chapter 12
19
Permanent Changes in Government Purchases • Theory – G, does not shift labor supply, Ls, which is fixed at L, and does not shift the labordemand curve, Ld. • the market-clearing real wage rate, (w/P)∗, ∗ does not change. • We conclude that a permanent increase in government purchases does not affect the real wage rate.
Macroeconomics - Barro Chapter 12
20
Permanent Changes in Government Purchases • Theory – We know from our analysis of income effects that a permanent rise in government purchases, G, by one unit reduces C in each year by roughly one unit.
Macroeconomics - Barro Chapter 12
21
Permanent Changes in Government Purchases • Theory – The intertemporal-substitution effect depends on the real interest rate, r. Since r does not change, the ntertemporal-substitution effect does not operate. Another substitution effect involves consumption and leisure, butwe have assumed that the quantity of labor and, hence, the quantity of leisure, is fixed. In any event, this substitution effect depends on the real wage rate, w/P, which does not change Macroeconomics - Barro Chapter 12
22
Permanent Changes in Government Purchases • Theory – our prediction is that a permanent increase in government purchases by one unit causes consumption to decrease by about one unit.
Macroeconomics - Barro Chapter 12
23
Permanent Changes in Government Purchases • Theory – Y= C+ I + G • the changes in C and G fully offset each other and, thereby, allow I to remain unchanged.
Macroeconomics - Barro Chapter 12
24
Permanent Changes in Government Purchases • Theory – we predict that a permanent increase in government purchases, G, • Reduces consumption, C, roughly one to one. • The variables that do not change include real GDP, Y; gross investment, I; the quantity of capital services, κK; the real rental price, R/P; the real interest rate, r; and the real wage rate, w/P.
Macroeconomics - Barro Chapter 12
25
Permanent Changes in Government Purchases
Macroeconomics - Barro Chapter 12
26
Temporary Changes in Government Purchases • Theory – Assume now that year 1’s real government purchases, G1, rise by one unit, while those for other years, Gt, do not change. That is, everyone expects that Gt in future years will return to the original level.
Macroeconomics - Barro Chapter 12
27
Temporary Changes in Government Purchases • Theory – Vt− Tt= −Gt – Vt− Tt falls by one unit, and households have one unit less of real disposable income. In subsequent years, Vt − Tt and, hence, real disposable income return to their original levels.
Macroeconomics - Barro Chapter 12
28
Temporary Changes in Government Purchases • Theory – Households would spread their reduced disposable income in year 1 over reduced consumption, Ct, in all years t. Therefore, the effect on year 1’s consumption, C1, will be relatively small. The propensity to consume out of a temporary change in income is greater than zero but much less than one.
Macroeconomics - Barro Chapter 12
29
Temporary Changes in Government Purchases • Theory – Y= C+ I + G – Y, is unchanged; real government purchases, G, are higher in year 1 by one unit; and consumption, C, is lower, but by much less than one unit. Consequently, equation (12.9) implies that gross investment, I, must fall. Macroeconomics - Barro Chapter 12
30
Temporary Changes in Government Purchases • Theory – Since the decrease in C is relatively small, the decline in I is large. That is, year 1’s extra G comes mainly at the expense of I, rather than C. – When the change in G was permanent, we predicted that most or all of the extra G came at the expense of C.
Macroeconomics - Barro Chapter 12
31
Government Purchases and Real GDP During Wartime: Empirical • We test the model by studying the response of the economy to the temporary changes in government purchases that have accompanied U.S. wars.
Macroeconomics - Barro Chapter 12
32
Government Purchases and Real GDP During Wartime: Empirical
Macroeconomics - Barro Chapter 12
33
Government Purchases and Real GDP During Wartime: Empirical • The data also show that the rises in real GDP are by less than the increases in government purchases. That is, aside from military purchases, the totals of the other components of real GDP are down during wartime. The model accords with this pattern. However, the components of real GDP other than military purchases do not fall nearly as much as predicted by the model. Macroeconomics - Barro Chapter 12
34
Wartime Effects on the Economy • Employment during wartime – The basic pattern is that the military took in a significant number of persons total employment expanded a little more.
Macroeconomics - Barro Chapter 12
35
Wartime Effects on the Economy • Effects of war on labor supply – At this point, there is no settled view among economists about the best way to understand labor supply during wartime. • A large expansion of real government purchases, G, means that households have less real disposable income. • Casey Mulligan (1998) argues that labor supply, Ls, increases during wartime because of patriotism. • the military draft would affect the labor supply of single womenn.
Macroeconomics - Barro Chapter 12
36
Wartime Effects on the Economy
Macroeconomics - Barro Chapter 12
37
Wartime Effects on the Economy • Employment Effects on Labor Markets – Prediction that a war reduces the real wage rate, w/P
Macroeconomics - Barro Chapter 12
38
Wartime Effects on the Economy • Effects of war on the rental market – a wartime increase in labor supply, Ls, led to an increase in labor input, L. This change affects the rental market, because the rise in L tends to increase the MPK (for a given quantity of capital services, κK). • The demand curve shifts right because the higher quantity of labor, L, raises the MPK for a given quantity of capital
Macroeconomics - Barro Chapter 12
39
Wartime Effects on the Economy • Effects of war on the rental market – a wartime increase in labor supply, Ls, led to an increase in labor input, L. This change affects the rental market, because the rise in L tends to increase the MPK (for a given quantity of capital services, κK). • The demand curve shifts right because the higher quantity of labor, L, raises the MPK for a given quantity of capital
Macroeconomics - Barro Chapter 12
40
Wartime Effects on the Economy
Macroeconomics - Barro Chapter 12
41
Wartime Effects on the Economy • Effects of war on the rental market – For a given capital stock, K, the rise in κK corresponds to an increase in the capital utilization rate, κ. – r = ( R/ P) · κ − δ(κ) • increases in R/P and κ imply that r increases.
Macroeconomics - Barro Chapter 12
42
Wartime Effects on the Economy • Effects of war on the rental market – The predictions for higher real interest rates during wartime conflict with the U.S. data.
Macroeconomics - Barro Chapter 12
43
