Academic journal article Public Finance and Management

An Analysis of Government Spending in the Frequency Domain

Academic journal article Public Finance and Management

An Analysis of Government Spending in the Frequency Domain

Article excerpt

Abstract

This paper utilizes frequency-domain techniques to characterize economically important properties of government spending and to determine the degree of substitutability between government and private consumption expenditures. Using post-war data for the United States, the analysis reveals that defense spending is best modeled as exogenous with respect to the aggregate economy and that nondefense spending (growth) appears to be white noise. Further, the unemployment rate has a very high coherency (correlation) at the business cycle frequencies with unemployment insurance. By contrast, social security benefits are largely insensitive to the business cycle but are influenced by seasonal and demographics factors. Finally, using data from 12 industrialized countries, the paper finds evidence, although inconclusive, suggesting that direct substitutability between government and private consumption spending is widespread and often of sizable magnitude. In the process the exercise illustrates how spectral techniques can be combined with a standard intertemporal optimizing model to deliver restrictions that are testable in the frequency, but not the time, domain.

(ProQuest Information and Learning: ... denotes formulae omitted.)

I. Introduction

Government spending in the United States fluctuates with the seasons, with business cycles, with intermittent wars, and with long-run demographics. For example, several spending programs are indexed for past price inflation at the beginning of each year; unemployment insurance benefits rise during recessions; defense spending spikes during wars; and transfer payments over the coming decades will be strongly influenced by the projected explosive growth in social security and Medicare spending as the baby- boom generation retires.

This paper quantifies such frequency-dependence of U.S. federal government spending over the post-World War II period using techniques from the spectral analysis of time series. More specifically, in section II, the paper identifies the important peaks of the estimated spectra of selected components of fiscal spending, using quarterly postwar data from the U.S. National Income and Product Accounts. The results generally are consistent with wellknown properties from the time domain.

In addition, the paper attempts to contribute to the issue of the macroeconomic effects of government spending which has received renewed academic interest in papers by Blanchard and Perotti (2002) and by Eichenbaum and Fisher (1998). In particular, we focus on the degree of direct substitutability between government and private consumption expenditures, a longstanding issue particularly well suited for application of spectral techniques. In section III, an intertemporal optimizing model of household consumption that allows for substitutability between government and private consumption spending is developed; it is established that the coherency (correlation) between these variables varies in a theoretically predictable way across frequencies. In section IV, these restrictions are matched against their sample counterparts using data from all G-10 countries plus Australia, and we find that the evidence, although inconclusive, suggests that direct substitutability is widespread and often of sizable magnitude. To our knowledge, such an approach has not employed before.

The use of frequency-domain techniques offers a different empirical perspective on economic relationships than the standard time-domain approach. Although all second-moment properties of a stationary time series would be identical in a large sample, differences arise given small samples; indeed, the existence of small samples helps to justify the study of government spending in the frequency, as well as, the time domain. Moreover, as mentioned, one can derive testable restrictions in the frequency domain that have no obvious counterpart in the time domain.

However, the spectral approach is not without its limitations. …

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