government debt, government spending, and private sector behavior

American Economic Association

Government Debt, Government Spending, and Private Sector BehaviorAuthor(s): Roger C. KormendiSource: The American Economic Review, Vol. 73, No. 5 (Dec., 1983), pp. 994-1010Published by: American Economic AssociationStable URL: http://www.jstor.org/stable/1814667 .

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Government Debt, Government Spending, and Private Sector Behavior

By ROGER C. KORMENDI*

A current-period tax reduction financed by issuing government debt shifts the timing of tax collection from the current period to the future. If the future taxes implied by government debt are not fully perceived and discounted by the private sector, there will be a "net wealth effect" that increases private sector consumption, thus reducing capital accumulation and growth. If, on the other hand, the implied future taxes are perceived and discounted by the private sector, the current-period tax reduction will be used to increase private saving to pay for the future taxes, and government debt will be absorbed without any real effects on the economy.'

The effects of government spending financed by current-period taxation also depend upon private sector perceptions.2 If the

benefits of government spending are ignored, private sector consumption will decrease in accordance with the reduction in permanent disposable income. To the extent that government spending is on consumption-type goods that are perceived as substitutes for privately provided consumption goods, there will be a relatively greater reduction in private sector consumption. To the extent that government spending is on investment-type goods yielding future goods and services that are perceived as substitutes for future privately provided consumption goods, there will be a relatively smaller reduction in private sector consumption.

The standard approach to modeling private sector consumption-saving behavior involves a rather asymmetric set of assumptions as to how the private sector perceives the various elements of government fiscal policy.3 Cur- rent-period taxes are assumed to be fully perceived, but current-period government spending is implicitly assumed to be com- pletely ignored by the private sector. In con- sidering permanent personal disposable income, the private sector is assumed to be forward-looking in its assessment of income and taxation. The stock of government debt is nevertheless included as part of the stock of private wealth, the implicit assumption

*Associate Professor of Economics, Graduate School of Business, University of Chicago, 1101 East 58th Street, Chicago, IL 60637. I thank Eugene Fama, Levis Kochin, Michael Mussa, Paul Evans, and an anonymous referee for helpful comments. I am particularly grateful to Daniel Benjamin for contributing many hours of discussion, and Laura Lahaye, who was a research as- sistant and valuable adviser on earlier drafts.

'The theoretical debate on the "burden of the debt" has been long standing. Gerald O'Driscoll (1977) documents Ricardo's nineteenth-century position. Robert Barro (1974) reopened the debate by introducing the fundamental issue of intergenerational transfers (also discussed in Merton Miller and Charles Upton, 1974). The empirical side of the debate was initiated by Levis Kochin's (1974) attempt to test for the effects of deficits on consumption and by Martin Feldstein's (1974) attempt to test for the effects of Social Security "wealth" on consumption. Other empirical contributions include Jess Yawitz and Laurence Meyer (1976), myself (1978) and J. Earnest Tanner (1978, 1979) with respect to the effects of government deficits and debt, and Barro (1978), Michael Darby (1979), and Dean Leimer and Selig Lesnoy (1982) with respect to Social Security wealth. See also interesting recent papers by John Seater (1982), who generates detailed tests of the effects of deficits and debt on consumption, Charles Plosser (1982), who ex- plores the effects of government spending and debt "shocks" on interest rates, and Feldstein (1982), who attempts tests similar to some in this paper (see fn. 29).

2Martin Bailey's (1962, 1971) development of the effects of government spending on private consumption

and aggregate economic activity is the seminal contribu- tion. Paul David and John Scadding (1974) extend Bailey's ideas and provide some supporting empirical evidence. More recently, Willem Buiter (1977) and myself (1978) developed models based on Bailey's earlier work. Barro (1981) has an interesting paper on related issues. See also David Aschauer (1982).

3The "standard approach" incorporates fiscal policy through the concept of personal disposable income and by including the stock of government debt as part of personal wealth. See, for example, the empirical specification of Albert Ando and Franco Modigliani (1963), which has been the basis of most empirical consumption studies since, and Feldstein (1974) for one of the more influential papers based on the Ando-Modigliani specification.

994



VOL. 73 NO. 5 KORMENDI: GOVERNMENT DEBT AND SPENDING 995

being that the private sector is too myopic to account for the effects of govemment debt on future taxes. Thus, in the standard approach, the perceptions of the private sector are not "rational." That is, their perceptions differ systematically with the actual current and future consequences of government fiscal policy.

In this paper, I draw on the work of Martin Bailey (1962, 1971) and Robert Barro (1974) to develop an altemative approach to modeling private sector consumption-saving behavior based on rational evaluation of the consequences of govemment fiscal policy. The theoretical considerations involved in this approach, which I term the consolidated approach, are discussed in Section I. Section II contains empirical results. First, I explore the robustness of a specification for the private sector consumption function based on the consolidated approach. Then I undertake tests designed to discriminate between the consolidated and standard approaches based on their differing implications as to the effects of govemment spending, current- period taxation, govemment interest payments, and the stock of govemment debt on private sector consumption. Finally, I present some evidence on the differing effects of components of govemment spending on private sector consumption implied by the consolidated approach.

I. Theoretical Considerations

In order to focus attention on the effects of govemment fiscal policy on private sector behavior, consider a simple version of the permanent income hypothesis.4 Current- period income, Y, is assumed to be contem- poraneously exogenous to consumption and decomposable into a permanent and a tran-

sient component. The permanent component is the expected yield, r, on the true (beginning-of-period) stock of wealth, W,*.5 If current-period income and a measure current- period wealth, W, can be observed, but true current-period wealth is not directly observable, the permanent income hypothesis involves an estimate of the permanent component of current-period income based on the available information. Current consumption, C,, is assumed to be a constant fraction of estimated permanent income.

The considerations above give rise to a familiar form for the consumption function:

(1) C,=ao+aY,1+a2W,+u,,

where u, is the error term. Equation (1) should be interpreted as a reduced form in which the estimated coefficients reflect the informational content of Y, and W, with respect to permanent income. If current-period values of Y, and W, both have positive informational content with respect to permanent income, O<al<1 and O<a2<r should obtain.6 Lagged values of both Y, and W, may enter the specification to the extent that they carry incremental information for current- period permanent income.7

The standard approach to incorporating government fiscal policy into equation (1) employs personal disposable income as the relevant income concept and a wealth concept that includes the stock of government debt. Such a formulation implicitly assumes that the private sector is too myopic to account for any effects of government debt

4In interesting recent papers, Robert Hall (1978), Marjorie Flavin (1981), Fumio Hayashi (1982), and others develop tests of a strong version of the permanent income hypotheses (PIH) explicitly derived from intertemporal utility maximization under rationality of ex- pectations. In this paper, I use a simpler version of the PIH in order to focus on the issues of how the private sector responds to government fiscal policy. An area of fruitful research would combine the issues of this paper with the methods developed in the papers cited above.

5I assume a constant expected yield on wealth for simplicity. The true stock of wealth, W,*, includes both human and nonhuman wealth.

61f Y, were equal to permanent income, a, = k and a 2 = 0 would obtain, where k ? 1 is the constant propor- tion of permanent income consumed. Similarly, if W, were equal to true W,*, then a, = 0 and a2 = kr. If both Y, and W, carry positive incremental information with respect to permanent income, 0 < a, < k and 0 < a2 < kr follows.

7In principle, any observable variable as of date t may carry incremental information with respect to fore- casting future income and hence permanent income. In practice, however, finding variables that have significant incremental ability to predict future income given the current and lagged values of income and wealth is difficult. See fn. 15.



996 TIIE AMERICA N ECONOMIC REVIEW DECEMBER 1983

on future taxes and ignores the benefits of government spending. I now turn to an alternative approach in which the private sector rationally accounts for the effects of government fiscal policy.

Consider first tax-financed government spending on goods and services. Drawing from the work of Bailey (1962, 1971),8 I treat the government as a firm or set of firms producing final goods and services from inputs.9 To preserve the theoretical focus on the consumption-saving decision, distinguish between that portion of government spending that yields utility to the private sector in the current period, government consumption (GCt), and that portion that yields utility to the private sector in future periods, government investment (GI,). Since demands for government-provided goods and services are registered through the political marketplace and the payments are received through the tax system, the value of government-provided goods and services may not equal their resource cost (i.e., the value of the foregone private goods and services). The difference between resource cost and value will be termed government dissipation (GD1). Total government spending on final goods and services, GS,, is thus the sum of three components: GC, + GI, + GD1. Government dissipation is simply a direct drain on the income flow of the economy and hence affects the level of total disposable income, which is defined as Y, - GD1, where Y, is income from all sources. While considerably different from the usual notion of personal disposable income, total disposable income is the correct measure of the current-period resource flow from all sources available for "disposition" either as total consumption (TCt), defined as the sum of government and private consumption, or total investment, defined as the sum of government and private investment.

Agents in the economy are assumed to make their consumption-saving decision tak-

ing into account their command over goods and services deriving from all sources -from the net private incomes including their ownership in private firms and from their claims to government provided final goods and services. This approach to incorporating tax-financed government spending on goods and services thus involves a simple consolidation of the public and private sectors.10 Under this consolidated approach to the permanent income hypothesis, total consumption is a constant fraction of the estimated permanent component of total disposable income, which gives rise to the following total consumption function:

(2) TCq = ao + ajY? + a2GD? + a3W? + Ul,

where now Y, is income from all sources and W, is wealth from all sources.'1 The variables Y, and GDt are entered separately because they may carry different information as to the permanent component of total disposable income. Lagged values of Yt, GDt and Wt may enter (2) to the extent that they carry incremental information with respect to permanent total disposable income. The coeffi-

8See fn. 2 for related references. 'Some portion of measured government spending

may be more appropriately considered to be inter- mediate inputs into the productions of private sector final goods and services and hence should be netted out of aggregate income to avoid double counting.

'(Issues as to whether different consumption goods (for example, meat today and potatoes today) are substitutes or complements are generally treated as being of second-order importance for determining the intertemporal allocation of resources through the consumption saving-decision. Hence, all private goods and services that provide utility today are aggregated into current- period private consumption. I treat government consumption in a similar manner. Such an aggregation procedure is strictly correct only if government consumption is essentially perfectly substitutable for private consumption. The more general case of less-than-perfect substitutability between private and government consumption involves some modifications in the analysis (see fn. 12), but entails no major changes in the structure and interpretation of the empirical results of Sec- tion II (see fn. 16).

" l Wealth from all sources should include both private and government wealth. Income from all sources and total consumption, therefore, should include the service flow deriving from government wealth. Because of the difficulty of measuring government wealth, I will work with the narrower concepts of wealth, income, and consumption that exclude government wealth and its service flow. (See the Data Appendix.) If the propensity to consume out of permanent income is close to unity, there will be no important effects of working with the narrower concepts.



VOL. 73 NO. 5 KORMENDI: GOVERNMENT DEBTA ND SPENDING 997

cients al and a3 are expected to be positive and a2 negative. Using the definition TC,-= PC, + GC, where PC, is private sector consumption, a specification for a private sector consumption function can be obtained as

(3) PCt = ao + aYt + a21GDt

+a22GCt + a3Wt +Ut

where the coefficient a22 =-1 and a21 in (3) is the same as a2 in (2).12

Transfer payments TRt, financed by current taxation, may redistribute wealth across people with different propensities to consume out of permanent income, thereby affecting aggregate private sector consumption. To account for this effect, one can augment (3) to include a4TRt. If, as generally argued, transfer payments shift wealth from low propensity to consume (high-income) individuals to high propensity to consume (low-income) individuals, an increase in transfers will increase aggregate private sector consumption, and a4 will be positive. The magnitude of a4 will then depend upon the discrepancies in propensities to consume and the extent to which changes in transfers are perceived to be permanent.13

I now incorporate debt financing by drawing on the work of Barro (1974).14 If the private sector rationally perceives the future taxes implied by debt financing, the present value of the implied future taxes equals the current taxes avoided by debt financing. Hence, the choice of tax vs. debt financing of current government expenditures leaves the private sector's consumption-saving decision

unaffected. Moreover, since the net wealth of the private sector is unaffected by debt finance, the stock of government debt outstanding is not net wealth and will not affect the private consumption-saving decision. Thus (3) remains unaltered by considerations of debt finance.

The standard and consolidated approaches yield quite different implications as to the effects of elements of government fiscal policy on private sector consumption-saving behavior. Under the standard approach, the private sector is assumed to base its consumption upon personal disposable income, defined as YDt=Yt-,-REt + TRt + GINT> where TX, is current taxation, RE, are corporate retained earning, and GINTt are government interest payments on its outstanding debt. Government spending, therefore, has no effect on private sector consumption, but current taxation, corporate retained earnings, and government interest payments do. Under the consolidated approach, government spending affects private sector consumption, but current taxation, retained earnings, and government interest payments do not. (Transfer payment can have effects under either approach.) The stock of government debt outstanding has a net wealth effect under the standard approach, but has no net wealth effect under the consolidated approach. In the next section, I exploit these differing implications to structure tests capa- ble of discriminating between the two approaches.

II. The Empirical Results

This section presents time-series evidence for the U.S. economy on the effects of government fiscal policy on private sector consumption-saving behavior. First I explore the robustness of an empirical specification of the private sector consumption function based on the consolidated approach. Then I undertake tests designed to discriminate between the consolidated approach and the standard approach based on their differing implications as to the effects of government spending, current-period taxation, government interest payments, and the stock of government debt on private sector consump-

12The coefficient a22 will be equal - 1 only if GC, and PC, are essentially perfect substitutes with respect to the consumption-saving decision (see fn. 10). If they are less-than-perfect substitutes, 0 < a22 < - 1 would hold, in which case a22 would also reflect the informational content of GC, with respect to the permanent component of GC,. Similarly, if government and private investment are less-than-perfect substitutes, it would be necessary to introduce the term a23GI, into (3), with a23 < 0. These considerations do not affect the interpretation of the empirical results of Section II (see fn. 16).

13To the extent that government consumption involves some wealth redistribution, the value of a22 will be affected correspondingly.

14See fn. 1 for related references.



998 THE AMERICAN ECONOMIC REVIEW DECEMBER 1983

tion. Finally, I present some evidence of the differing effects of government consumption, investment, and dissipation on private sector consumption implied by the consolidated approach.

A. Estimates under the Consolidated Approach

Consider as an empirical specification of the private sector consumption function the following modified version of equation (3):

(4) PCt = ao + ajY + a12Yt-1+ a2GS,

+ a3Wt + a4TR, + u,.

There are three differences between (3) and (4). First, (4) has been explicitly augmented to account for the effects of transfer payments, a4TR,. Second, following most previ- ous consumption studies, (4) includes lagged real income Yt,_ to reflect any incremental information it may contain as to permanent income.15 Third, for the time being, (4) col- lapses the effects of GCt, GIt, and GDt into the single variable GS,, government spending, on goods and services. In reflecting all three components of government spending, the coefficient a2 should be negative and between zero and minus one.'6

I use the following data series over the period 1929-76, a detailed account of which is given in the Data Appendix. I use National Income and Product Accounts (NIPA) consumer expenditures on nondurables and services plus an imputed service flow from

the Bureau of Economic Analysis (BEA) stock of consumer durables as a measure of P4;17 NIPA net national product as a measure of Y,; NIPA federal, state, and local government spending on goods and services as a measure of GS,; and NIPA transfer payments from federal, state, and local governments as a measure of TR,. As a measure of Wt, I use the stock of private national wealth from Raymond Goldsmith (1956, 1962, and updates) plus human wealth from John Kendrick (1976).18

The time-series data in this study are nonstationary in the levels, and detrending does not induce stationarity. It is now generally known (see, for example, C. J. Granger and Paul Newbold, 1974, and Charles Plosser and G. William Schwert, 1977) that when nonstationary time-series are used in regression, spuriously significant coefficients can result unless care is taken in specifying the error structure. Thus, Table 1 reports the results of estimating (4) over the years 1930-76 in three forms: ordinary least squares (OLS) in the levels, generalized least

15Lags of W,, GS,, TR,, and lags of Y, greater than one had no significant effects and hence are excluded from the reported specification. As discussed in fn. 7, any observable variable may carry incremental information with respect to permanent income. Barro (1978), for example, includes the interaction of unemployment and current-period income, UN, Y,, to reflect potential cycli- cal information in the unemployment rate. This variable did not have significant effects in my specifications.

16If GS,=GC,, a2=-1; if GS,=GI,, a2=0; if GS, =GD,, - k < a2 < O, where the magnitude of a2 depends upon the extent to which changes in GD, are "permanent." Since specification (4) includes only GS, and not the components separately, the earlier strong assumption that GC, and PC, are perfect substitutes does not affect the qualitative properties of a2 (see fnn. 10 and 12).

17Many consumption studies use consumption expenditures, CX,, i.e., expenditures on nondurables, services, and consumer durables. Consumer durables, however, are primarily investment and hence are not part of the theoretical concept of current period consumption. See Darby (1977-78) for an attempt to develop a consumer expenditure (as opposed to a consumption) function. Recently, Hayashi (1982) found that his tests of the permanent income hypothesis are rejected when CX, is used but are not rejected when a measure similar to our PC, is used. As it turns out, the main results in this paper are robust to using consumer expenditures, consumption on nondurables and services, or (in contrast to Seater, 1982) nondurables alone as the dependent variable.

18The data on national wealth and human wealth are available only through 1969. 1 extrapolated the series to 1976 using the recently constructed BEA stock of private net residential plus fixed nonresidential capital, as discussed in the Data Appendix. I also undertook all the empirical work in this paper using the BEA measure of private capital, K,, both with and in place of my measure of W,. The results are not much affected by doing so, but the Goldsmith-Kendrick measure of W, almost always had considerably more incremental explanatory power than the BEA measure. The results reported in this paper stop in 1976 because the measure of the market value of the stock of government debt, to be discussed and used later, is available only through 1976. Updating the results not involving the stock of government debt through 1979 yields no essential changes.



VOL. 73 NO. 5 KORMENDI: GOVERNMENT DEBTAND SPENDING 999

squares (GLS) correction for first-order autocorrelation in the levels, and OLS in the first differences. A quick inspection of Table 1 reveals that the coefficient estimates are virtually the same across the three forms of estimation, which indicates that the results do not suffer from spurious regression prob- lems. Since the first differences generally yields white noise error structure, and since working with the stationary data is generally desirable, I will report only the first difference form of estimation throughout the re- mainder of this paper.19 As with Table 1, however, the results from GLS level estimation are always very close.

The results on the individual coefficients in Table 1 conform to the implications of the consolidated approach quite well.20 The coefficients on Y, and W, are both of reasonable magnitude and several standard errors

TABLE 1-1930-76

OLS GLS First Difference

y, .31 .32 .32 (.02) (.02) (.02)

[15.1] [16.4] [13.8] Y. - l .03 .02 .03

(.02) (.02) (.02) [1.5] [1.5] [1.7]

GS, - .22 -.22 -.23 (.02) (.02) (.02)

[-14.1] (-13.6] [12.2] WI .046 .044 .040

(.003) (.004) (.007) [18.1] [11.8] [5.8]

TR, .63 .69 .67 (.08) (.11) (.14) [7.5] (6.1] [4.8]

Pi - .63 - (.12)

R 2 .999 .999 .887 SER .0216 .0169 .0187

rl .61 .23 .13 (.14) (.14) (.14)

r2 .14 -.10 -.17

(.14) (.14) (.14) r3 -.12 -.16 .18

lAl4 (.14) (.14)

Notes: Standard errors are shown in parentheses, t-sta- tisties are in brackets (rounding may affect comparabil- ity); constant terms were estimated but are not reported (for first difference regressions constants were insignificantly different from zero); Pi is the estimated ARI coefficient; SER is the standard error of the regression residuals; rl, r2, r3 are the first three sample autocorrelations of the residuals with their (approximate) standard error in parentheses.

from zero. The coefficient on TRt, though perhaps somewhat large, is not unreasonable and suggests that transfers generally take place from "rich" to "poor," and that changes in transfers are largely permanent.21 Most important for the consolidated approach, the negative coefficient on GS, is of reasonable magnitude and several standard errors from zero.

'9The AR1 coefficient, pi =.63, is relatively large, and does not seem to account for all of the first-order autocorrelation (with r, =.23), whereas the first difference specification yields residuals quite consistent with white noise. Throughout this paper, first differences generally yield better properties for the residuals.

20The results in Table 1 maintain the assumption of orthogonality between the residuals and the regressors in (4). If, for example, orthogonality between Y, and the error term fails to hold, our estimates of all the coefficients could be affected. Jerry Hausman (1978) provides a test for orthogonality based on including an instrumental variable estimator of the problematic regressor in the specification in question. Thus, I estimated the following first difference form of (4), augmented to include an instrumental variable for A Y, (standard errors are in parentheses):

APC, =.36AY? .02 AYl> -.25AGS,+.04AW, (.04) (.02) (.03) (.01)

+.71 A TR I.07A Y! VI + u,

(.14) (.05)

where AYIV, is the instrumental variable created from the fitted values of regressing AY, on the vector (AY, 1, AGS,, AW,, ATR,, AGS,1_, AW,_., ATR,-1, AUN1_j, ASUR, l), where UN, is the unemployment rate and SUR, is the government surplus. Note that AY! kt has a small coefficient (relative to AY,) and is rather precisely estimated. Thus, whereas the null hypothesis of orthogonality is not rejected, the small standard error indicates that it is not because of a lack of power. Finally, none of the other coefficients are much affected by the inclusion of A YI V, indicating that to the extent that orthogonality fails to hold it does not have important effects (see fn. 29).

21 If one takes the point estimate as reflecting a structural relation, there are important implications for the effects of transfers on capital accumulation. For example, in 1966 per capita transfers were $220 (1972 dollars) and in 1979 they were $677 (1972 dollars). Net private domestic investment was approximately $450 (1972 dollars) per capita in 1979. Thus, a coefficient of .7 (for TR,) implies that net investment would have been about $760 (1972 dollars) per capita (or about 70 percent higher) in 1979 if transfers had been maintained at their 1966 level.




TABLE 2a

1930-40/ 1947-76 1930-46 1947-76

Y, .32 .34 .28 (.02) (.04) (.03)

[13.8] [9.0] [8.6] Y.- .03 .04 .03

(.02) (.03) (.03) [1.6] [1.2] [1.0]

GS, -.20 -.24 -.17 (.06) (.03) (.03)

[-3.41 [-9.01 [-2.31 Wt .041 .020 .034

(.008) (.018) (.015) [5.1] [1.1] [2.3]

TR, .66 .73 .66 (.14) (.27) (.15) [4.71 [2.81 [3.5]

R2 .902 .950 .806 SER .0183 .0175 .0198

D- W = 1.7]b .07 .14 (.24) (.18)

r) - -.56C -.02 (.24) (.18)

r3 - -.02 -.08 (.24) (.18)

F 1.32 0.68 0.68 (MSL) (.28) (.67) (.67)

Notes: See Table 1; F in the last row is the F-statistic for testing the joint null hypothesis of stability of the coefficients and homoscedasticity of the residuals between the subperiod in question and the full 1930-76 period, MSL is the marginal significance level of the test.

'Form of estimation is first difference. bWith six deleted rows, autocorrelations are not re-

ported. In its place is the Durbin-Watson statistic. Cr2 is significantly different from zero at the 5 percent

level. However, the value of r2 is due to one observation, that in 1942. Upon its deletion r1 =.10, r2 = -.09 and r3 =.15.

In most consumption studies, the years around World War II, usually 1941-46, are excluded from the sample, the argument being that fundamental structural changes "may" have taken place during the war. On the other hand, if the major factors affecting the private consumption-saving decision have been accounted for, the consumption specification should do as well in war years as in "normal" times. In Table 2, I present estimates of (4) over three subperiods: the period excluding the war-related years 1941-46, (i.e., 1930-40/47-76); the "turbulent period" of 1930-46; and the "tranquil period" of 1947-76. Comparing the estimates in Table

2 with those in Table 1 reveals the coefficients to be stable over the subperiods in question. The F-statistics reported in the last column of Table 2 provide formal tests of the joint null hypotheses of stability of the coefficients and homoscedasticity of the residuals. The joint null hypotheses are not rejected by the data.22

Recently, Hall (1978) has argued that only " new information" should affect current- period consumption, given last-period's consumption, because last-period's consumption decision will reflect the relevant information to that point in time as to permanent income. Consider then estimating the following system of equations in place of (4), written explicitly in first differences:

(5) A X(L) X

( ob) RXt + ( RX )tI

where A Xt denotes the vector of variables (AYt, AGSt, AWt, ATRt)', X(L) is a matrix of polynomials in the lag operator L conform- able to (APCt-1, AXt-1)', b' is a 4 x 1 coefficient vector, 0 is a 4 x 4 matrix of zeros, et is the residual for the A PCt equation, and RX, = (RYt, RGSt, RWt, RTRt)' is the vector of residuals for the four A Xt equations. Esti- mating system (5) under the restriction that et is orthogonal to RXt identifies b'. The vector autoregression structure of (5) filters out "old information" from A Xt leaving a

22The stability of the specification with respect to the World War II years 1941-46 is perhaps surprising in light of the often argued contention that wartime price controls may have affected private consumption-saving decisions. To test this more specific hypothesis, I included in (4) a "synthetic" variable measuring the "stringency" of price controls, STRPC,, taking on values of .14 for 1943, .28 for 1944, .43 for 1945, .33 for 1946, .14 for 1947, and 0 otherwise. The variable STRPC, was developed using Paul Evans' (1982) estimates of the effects of wartime price controls on the demand for money. Including STRPC, in (5) yielded a marginally significant negative coefficient (It = - 1.6), with no effect on the other coefficients. Including STRPC, in the specifications estimated later in the paper yielded mixed results for STRPC, and no effects on other efficients.




TABLE 3

1930-76

RY, .29 (.03)

[10.2] RGS, -.21

(.02) [-8.5]

RW' .023 (.015)

[1.5] RTRt .63

(.20) [3.1]

R 2 .893 SER .0200 ri -.02

(.14) r2 -.08

(.14) r3 .01

(.14)

Notes: See Table 1.

vector of (potentially correlated) white noise residuals, RX,, that should be closer to the " new information in AX,." Table 3 presents the estimated b' coefficients from system (5) when the elements of A(L) are second-order polynomials in L. The coefficients are quite close to those reported in Table 1.23

B. The Consolidated vs. StandardApproach

I now turn to tests designed to discriminate between the standard and consolidated approaches to private sector consumption behavior. To this end, I use the definition of personal disposable income, YDL=Y,-TX,-RE, + TR, + GINT7, to develop the following augmented version of (4),

written explicitly in first differences:

(6) APC,=ao+a11AYt+al2AYt-1

+ a2AGSt + a3AW, + a4ATR,

+ aATX, J a6ARE, + a7AGINT, + u,

where TX, is measured as NIPA government receipts (taxes) from all sources; RE, is measured as NIPA corporate retained earnings; and GINT is measured as NIPA net interest payments by federal, state, and local governments. See the Data Appendix for details.

Equation (6) nests the specifications of the standard and consolidated approaches. Un- der the standard approach, the private sector is assumed to ignore government spending, implying a2 = 0, and private consumption is assumed to depend upon permanent personal disposable income, which implies negative coefficients for ATX, and ARE, (aS < 0 and a6 < 0) and a positive coefficient for AGINT, (a7 > 0).24 Under the consolidated approach, government spending affects private consumption negatively, implying a2 <0; the choice of tax vs. debt finance leaves private sector consumption unaffected, implying as = 0; 25 retained earnings are per-

23Hall's strong hypothesis that only new information will affect current-period consumption implies that the coefficients of lags of AX, in the A PC, equation in (5) should be zero. A likelihood ratio test rejects this restriction at the 1 percent level. See Flavin for a discussion of such tests and related issues. Note that estimates of b can be obtained equivalently by including current values of AX, in the A PC, equation (in place of A RX,), but tests of Hall's strong hypothesis require full system estimation.

24Under the standard approach, the coefficients of the components of personal disposable income should reflect the effects of changes in these components on permanent disposable income. As long as the effects on permanent disposable income have the same sign as the effect on current-period disposable income, the implied signs (a5 < 0, a6 < 0, a7 > 0) follow.

2sThe change in the current period government surplus, can be written as ASUR, ATX, - AGS, - ATR, - AGINT,, since total government expenditures are equal to spending on goods and services plus transfers plus interest payments (plus transfers to foreigners plus net subsidies to government enterprises both of which are relatively small and conceptually may be included in GS). Thus, by controlling for AGS,, ATR, and AGINT,, the coefficient on /ATX, in (6) reflects the effect of jointly increasing TX, and SUR, (lowering the deficit) on private consumption. The analysis does not explicitly account for the effects of open market operations by the Federal Reserve Board that "monetize" part or all of the current-period deficit. These operations can be thought of as a substitution of current and future inflation taxes for current and future general taxation. Under the standard approach, inflation taxes do not affect consumption, and hence a5 < 0 still obtains. Under the consolidated approach, these taxes are rationally accounted for, and



1002 THE A MERICA N ECONOMIC RE VIE W DECEMBER 1983

ceived as private saving, the return to which accrues to individuals through their ownership in corporations, implying a6 = 0; 26 and government interest payments on its stock of outstanding debt, reflecting the anticipated consequences of prior debt financing, have no effect on private sector consumption, implying a7 = 0.

Table 4 presents the results of estimating (6) over the full 1930-76 period and over the period 1930-40/47-76, which excludes the war years. In both cases, the coefficients for MY, AW, ATR, and (most importantly) AGS,

are virtually the same as those estimated in Tables 1 and 2. The coefficients for ATX,, ARE,, and AGINT7, on the other hand, are each insignificantly different from zero, and generally of the wrong sign from that pre- dicted by the standard approach.27 Though the import of these results is clear, a few formal tests are in order. First, the t-statistic for a2 reported in Table 5 decisively rejects

TABLE 4a

1930-40/ 1930-76 1947-76

Y, .29 .30 (.04) (.05) [6.5] [6.1]

Y1- . 04 .04 (.02) (.02) [1.8] [1.6]

GS, -.22 -.19 (.02) (.06)

[-11.4] [- 3.1] W, .040 .041

(.007) (.008) [5.5] [5.0]

TR, .72 .67 (.16) (.16) [4.5] [4.1]

TX, .06 .01 (.08) (.10) [0.7] [0.1]

RE, .10 .10 (.12) (.13) [0.8] [0.6]

GINT, -.30 .63 (.83) (.98)

[ - 0.4] [0.6] R2 .890 .906

SER .0192 .0188 .12 [D- W = 1.8]b

(.14)

r2 -.12 (.14)

r3 -.21 (.14)

Fc 0.27 0.35 (MSL) (.85) (.79)

Notes: See Table 1. aForm of estimation is first difference. bSee fn. b, Table 2. CF in the last row is the F-statistic for testing the null-

hypothesis that the coefficients of TX,, RE,, and GINT, are all zero.

the null hypothesis of the standard approach, a2 =0, in favor of the consolidated alternative, a2 < 0. Second, the F-tests reported in the last column of Table 5 do not reject the null hypothesis of the consolidated approach, a5 = a6 = a7 = 0.28 Finally, the

hence a5 = 0 is still the implication. Thus, considerations of "monetization" should not affect the tests in question. See Seater (1982) for tests relating to these issues.

26This argument and empirical evidence in support of it was presented in Feldstein (1973) and David and Scadding.

27The results in Table 4 are quite robust. Respecify- ing the equation in the levels and estimating it OLS or GLS does not alter the results. Neither does respecifying the equation in "new information" form, as in system (5). Using NIPA consumption expenditures as the dependent variable changes the coefficients somewhat but affects neither their qualitative interpretation nor the key tests. Including measures of the stock of consumer durables, government wealth and a long-term corporate bond interest rate yields insignificant coefficients and does not affect the other coefficients. Including A TX, -1, ATR,_1, ARE,-1, and AGINT,_1 (or AYD,-1) yields insignificant coefficients with no effects on the other coefficients. Note that when (6) is further augmented to include AYD,_l or ATX,_1, ATR,- , ARE,-I, and AGINT,_ 1, the following equation obtains a special case:

(a) APC,=bo+b11AYD+?b12AYD,1

+ b2 AW, + b3ATR1 + e,.

This equation is of interest because it is the first difference form of the specification generally associated with the standard approach (augmented to include the effect of transfers). The restrictions that generate this equation are decisively rejected by the data.

28The relation between the tests in Table 4 and tests undertaken by Tanner (1978) bear some discussion. Consider the following augmented version of (a) in fn. 27:




coefficient of TX, is both small in magnitude and estimated precisely enough to reject the hypotheses a5 = a2 and a5 = - a, at the 1 percent level, indicating that failure to reject a5 =0 is not due to lack of power in the test.29

If the future taxes implied by government debt are not perceived and discounted by the private sector, as assumed under the standard approach, the market value of the stock of government debt outstanding, GB, should have a "net wealth effect" on private sector consumption. One can test this effect30 by augmenting (6) to include a8AGB,. I use Seater's (1981) recently constructed series on the market value of the stock of federal, state, and local government debt outstanding (at the beginning of the period) as a measure of GB,.31 Under the standard approach, gov-

(b) APCt=bo+b11AYD,+b12AYDt1++b2AWt

+ b3ATRt + b4AREt + b5ASUR, + e,.

By including A RE,, one attempts to test for whether retained earnings are perceived as income (b4 > 0). By including A SUR,, one attempts to test whether the reduced future taxes implied by the current surplus are perceived as income (b5 > 0). Variants of this equation were estimated by Tanner (1978). (He used consumer expenditures, did not include transfers, did include cer- tain other variables, and used a levels specification to cite some of the differences, but for the ensuing discussion these differences are not crucial.) Estimating (b) with my data yields a significant b5 > 0, but b5 = bl can be rejected in favor of b5 < bl at the 5 percent level. Tanner found sirmilar results. As it turns out, observing bl > b5 > 0 in a specification such as (b) is not evidence with power against the null hypothesis that future taxes are not perceived. To see this, note that equation (b) is a special case of (6), when augmented to include a13AYD,-1. Using the definitions ATX, = AGS, + A TR, + AGINT, + ASUR, and AY, aAYD, - ATR, - AGINT, + A RE, + A TX, (6) can be rewritten as

(c) APC,=aO+a11AYDt+al2AY,-l+al3AYD,-1

+ (a2 + all + a5) AGS, + a3AWt

+ (a4 + a5) ATR, + (as + all) ASUR,

+ (a6 + al1) ARE,

+ (a7 + a5) AGINTt + u,.

Now suppose that future taxes are not perceived and that a12 -0, a2 = 0, and - all < a5 < 0, in which case all > - a5 reflects differing informational content of income and taxes for permanent personal disposable income. In this case, estimating (b) could yield bl, > b5 > 0 even though future taxes are not perceived. (Tanner, 1978, p. 319, fn. 4, explicitly recognizes that b5 < bl, does not reject full perception of future taxes but does not seem to realize that b5 > 0 does not reject the null hypothesis of no perception of future taxes.) As it turns out, when (c) is estimated with my data instead of (b), the results are virtually the same as those in Table 4, with - all < a2 < 0 and coefficients on a13, a5, a6, a7 close to zero. Thus, estimating (b) yields bl, > b5 > 0 because AGS, is excluded (with its coefficient a2 + all > 0) not because as < 0.

29Feldstein (1982) structures tests of what he calls "pre-Ricardian" hypotheses that are similar to those we

report in Table 4. In particular, Feldstein jointly includes a government spending variable and a tax variable in a consumption expenditures equation. Under OLS estimation, he reports a significant negative coefficient of -.10 for his government spending variable and an insignificant negative coefficient of -.02 for his taxation variable. Arguing that taxation is endogenous with respect to consumption, he substitutes an instrumental variable estimate for his tax variable and reports that the government spending coefficient becomes -.001 with a standard error of .13 and the tax coefficient become -.22 with a standard error of .15. He interprets these results as rejecting the "pre-Ricardian" hypotheses. Unfortunately, Feldstein does not provide the information on his data construction necessary to repli- cate his results. Using the data of this study, detailed in the Data Appendix, in specifications similar to Feld- stein's yields consistently significantly negative coefficients for government spending in the range -.15 to -.25 and consistently insignificant, mostly positive coefficients for taxation. In particular, using lagged taxation as the instrument (as per Feldstein) for current taxation in (6) yields a2 = -.22 with a standard error of .02 and a5 =.18 with a standard error of .32.

30It is possible to interpret the small and insignificant coefficient for ATX, found in Table 4 as indicating that changes in current taxation contain little incremental information with respect to permanent taxation, even if the implied future taxes associated with deficits are not perceived at all. The market value of the stock of government debt outstanding, on the other hand, is already a capitalized value and hence reflects its implied permanent tax flow directly.

31 In an earlier version of this paper, a different measure of the market value of the stock of government debt outstanding was constructed for 1929-69 using data on the maturity structure, market yields by maturity, and the aggregate par value of federal, state, and local debt outstanding in the hands of the public. The correlation between that measure and Seater's is .93 in the levels and .94 in the first differences. Using that alternative series (updated through 1976) produces very similar results to those obtained with Seater's measure. Seater's measure is preferable because it is based on a detailed compiling of the actual market values.




TABLE 5a

1931-40/ 1931-76 1931-76 1947-76

Y, .29 .32 .33 (.04) (.02) (.02) [7.3] [14.8] [14.1]

Y, 1 *.07 .06 .05 (.02) (.02) (.02) [3.3] [3.0] [2.2]

GS, -.23 -.23 -.21 (.02) (.02) (.06)

[- 12.8] [- 13.2] [- 3.5] WI .025 .028 .032

(.008) (.008) (.009) [3.0] [3.4] [3.5]

TR, .83 .78 .74 (.15) (.14) (.009) [5.6] [5.6] [3.5]

TX, .07 - - (.08) [0.9]

RE, .10 - -

(.11) [0.9]

GINT, 1.15 - -

(.91) [1.3]

GB, -.055 -.036 -.032 (.018) (.015) (.020)

[- 2.9] [- 2.4] [- 1.6] R 2 .911 .902 .910

SER .0175 .0176 .0178 ri --.02 .05 [D- W = 1.6]b

(.14) (.14) r2 --.07 -.15 -

(.14) (.14) r3 --.14 -.12 -

(.14) (.14) FC - 1.2 -

(MSL) (.32)

Notes: See Table 1. aForm of estimation is first difference. bSee fn. b, Table 2. CF in last row is the F-statistic for testing the null-

hypothesis that the coefficients of TR,, RE, and GNT, are all zero.

ernment bonds are "net wealth," implying a8 > 0; under the consolidated approach, the implied future taxes are perceived and discounted, implying a8 = o.32

Table 5 presents the results of estimating (6) augmented to include a8 AGB, over 1930-76. The coefficient on government debt, a8 = -.054, is negative and almost three standard errors from zero. Inferences as to a2 <0 and a5 = a6 = a7 = 0, however, are basically unaffected,33 and so Table 5 also contains the results of imposing the restriction a5= a6 =a7 =0. Over 1930-76, the coefficient on government debt, a8 = -.036, is less negative but more than two standard errors from zero. Excluding the war years yields a negative coefficient, a8 = -.032, that is 1.6 standard errors from zero. These results should be contrasted to those for "real wealth," W, for which the coefficient is always significantly positive.34

The implications of these results for the question of the extent to which the future taxes implied by government debt are discounted can be illustrated as follows. If the expected real yield on government debt is around 3 percent and the propensity to consume out of permanent income is close to unity, then a8 >.02 would be the case if future taxes are not discounted at all. The 1930-40/47-76 subperiod results imply that the critical value a*, for which a8 > a* has 5 percent probability of being true, is a* = .002. Thus, there is less than a 5 percent probability that future taxes implied by government debt are less than 90 percent discounted.35

In view of the significance levels of the negative coefficients for AGB, reported in Ta- ble 5, an interpretation of the negative coeffi-

32Under the standard approach, the stock of government debt is included as part of the stock of net wealth, implying ag = a3. However, even if the implied future taxes are not perceived at all, a, < a3 may result if the yield on GB, is less than the yield on W,, reflecting a lower risk premium.

33The coefficient on AGINT is very large, but is estimated very imprecisely. This is due to the fact that there is an order of magnitude of less variation in AGINT than the other regressors.

34The results in Table 5 are quite robust. Altering the specification as discussed in earlier footnotes does not affect the results. In particular, augmenting system (5) to include AGB, in the A X, vector also yields similar results. Also, including the stock of Social Security wealth as measured by Leimer and Lesnoy yields a small and insignificant coefficient with no effects on the other results.

35For the 1930-40/47-76 regression, a8 is estimated as a8 = -.032 with a standard error of .020. The 5 percent level for a one-tail test places a* 1.7 standard errors from a , i.e., a* =.002, which is less than 90 percent of the values of a8 consistent with no perception of future taxes, a8 >.02.



VOL. 73 NO. 5 KORMENDI: GO VERNMENT DEBT A ND SPENDING 1005

cient deserves some consideration. The real income stream deriving from government debt involves inflation risk and some default risk to holders of the debt. The future tax stream implied by the debt, on the other hand, involves that same inflation and default risk plus considerable additional risk as to both its intertemporal and cross-sectional incidence. Thus, in rationally assessing the future tax consequences of government debt, the current certainty equivalent value of the future taxes may exceed the current certainty equivalent value of the income stream (which is simply the market value of the debt). In such a case, the net wealth of the private sector is adversely affected by government debt, implying a negative effect for AGB, (and a positive effect for ATX,) on private

36 consumption.

C. Differential Effects of Components of Government Spending

The consolidated approach to the private sector consumption-saving decision yields implications for differing effects of the three components of government spending: government consumption should decrease private sector consumption one-for-one; government investment should have no effects on private sector consumption; and government dissipation should decrease private sector consumption in accordance with the implied reduction in permanent total disposable income.37 The BEA provides classifi- cations of government spending that can be used in rough correspondence to the theoretical components to structure tests for these differences.

Consider first the largest single category of government spending- defense expenditures, DX,. Conceptually, defense spending may be either "wealth-augmenting" or " wealth-maintaining." Wealth-augmenting defense spending is in essence a form of government net investment. In the nineteenth century, defense spending in the United States was probably significantly wealth-augmenting in nature. For example, as a result of the war against Mexico and the Spanish-American war, the resource base of the U.S. economy was considerably ex- panded. Wealth-maintaining defense spending, on the other hand, is undertaken to maintain national wealth against an outside threat. That is, if an outside threat increases the expected depreciation (expropriation) of the capital stock, increased defense spending would be necessary to maintain that stock. Wealth-maintaining defense spending is in essence a form of government dissipation.38 Over the period 1930-76, U.S. defense spending was probably largely wealth-maintaining and hence government dissipation, though arguably it may have been partly government net investment as well.

In the general category of nondefense spending, some necessarily arbitrary classification scheme must be undertaken if measures of government consumption, investment, and dissipation are to be constructed. The BEA has partially undertaken such a classification in the construction of its series on government fixed capital formation. (See the Data Appendix for details.) In the empirical work below, I will use this series as a measure of government investment, the difference between nondefense spending and this series as a measure of government consumption, and make no attempt to measure

36Barro argues along similar lines that "individual uncertainty" with respect to the future effects of government deficits may "make people sufficiently nervous to reduce their consumption demand when taxes are re- placed by public debt issue" (1976, p. 346).

37These implications follow from the strong form of the consolidated approach in which government consumption and investment are perfectly substitutable for private consumption and investment, respectively. If GC, and GI, are only imperfectly substitutable for their private counterparts, they both could have negative effects on private consumption (see fn. 12).

38Defense spending is in this view part of gross investment, but not net investment. In reducing total disposable income, wealth-maintaining defense spending reflects the expected effect of the outside threat, not a "waste" of resources. The broader category of government dissipation includes waste as well. Defense spending may involve "wasted resources" without affecting the interpretation of the empirical results. See Earl Thompson (1974), which posits a similar view of defense spending and develops interesting and rich implications for tax incidence.



1006 THE AMERICAN ECONOMIC RE VIEW DECEMBER 1983

the government dissipation component of nondefense spending.

Consider now estimating the following modified version of (4), written in first differences:

(7) APCt=aO+a11AYt+a12AYt-1

+a21ADXt + a22 AGCt + a23AGIt

+ a3AWt + a4ATRt + Ut,

where DXt is NIPA defense spending, GIt is the BEA series on government net fixed- capital formation, and GCt (equal to GSt - DXt - GIt) is the measure of government consumption (see the Data Appendix for details). If DXt is, in fact, government dissipation, its coefficient a2l should be negative.39 If GCt and GIt are precisely measured and perfectly substitutable for private consumption and investment, respectively, a22 =

-1 and a23 =0 would be the implied coefficients. More generally, if GCt and GIt are imperfect substitutes for private consumption and investment, but with GCt a better substitute than GIt for private consumption, then a22 < a23 < 0 should hold. However, if GCt and GIt are dominated by measurement (classification) error, a22 = a23 < 0.40 Thus, with respect to equation (10), the following tests are of interest: (i) a2l < 0 vs. a2l = O, (ii) a23 < 0 vs. a23 = 0, (iii) a22 < 0 vs. a22 = 0, (iv) a22 = -1 vs. a22 *- 1, and (v) a22 < a23 vs. a22 = a23-

TABLE 6a

1931-76

Y. .31 (.02)

[13.6] y_1 - I.04

(.02) [2.1]

WI .039 (.008)

[4.8] TR, .72

(.14) [5.0]

DX, --.23 (.02)

[-10.3] GC, -.28

(.15) [-1.9]

GI, -.07 (.14)

[-0.5] R 2 .893

SER .0187 .12

(.14) r2 --.13

(.14) r3 --.16

(.14) Fb 1.8

(MSL) (.19)

Notes: See Table 1. a Form of estimation is first difference. bF in last row is the F-statistic for testing the null

hypothesis that the coefficients of GC, and GI are equal.

Table 6 presents the results of estimating (7) over the period 1930-76. The coefficients of YT, AW, and ATR, are all close to those found in Table 1. The coefficient of ADX, is negative and several standard errors from zero, which is consistent with defense spending being largely wealth-maintaining, and hence government dissipation, rather than net government investment. The coefficient of AGIt, a23 =-.07, is small and less than one standard error from zero. The coefficient of AGCt, a22 = -.28, can be easily rejected as being equal to -1, but it is also different from zero at the 5 percent level and different from a23 at the 20 percent level. Thus, although one can easily reject the strong joint hypothesis that GCt is precisely measured

39Wealth-maintaining defense expenditures can reflect both permanent and transient levels of outside threat. The effect of a change in defense spending on private sector consumption depends upon the information as to permanent defense spending and hence permanent total disposable income.

40Although nondefense spending NDX, can contain consumption, investment and dissipation, I am decom- posing it into only GI, and GC, = NDX, - GI,. Thus, if the BEA measure of GI, is dominated by measurement (classification) error, then GI, and GC, together would contain no more information than NDX, alone, and hence a22 = a23 would obtain and take on a value between zero and -1. To the extent that measured and true GI, are correlated and measured, and measured and true GC, are correlated, a22 < a23 < 0 will hold. How- ever, only if measured GI, contains no consumption or dissipation will a23 = 0 and only if measure GC, contains no dissipation or investment will a22 = -1.



VOL. 73 NO. 5 KORMENDI. GOVERNMENT DEBT AND SPENDING 1007

and substitutes for private consumption one- to-one, the results do provide some suggestive evidence for differential effects of the investment and consumption components of government spending.4"

III. Conclusion

In the standard approach to modeling private consumption behavior, perceptions of the private sector with respect to the current and future consequences of government fiscal policy are not fully rational. In particular, in basing consumption on personal disposable income and a wealth concept that includes that stock of government debt, the implicit assumptions are that the private sector ignores the benefits of government spending and fails to account for the effects of government debt on future taxes. In this paper, drawing on earlier work of Bailey (1962, 1971) and Barro (1974), I developed an alternative approach to modeling private consumption behavior based on a rational consolidation of the public and private sectors. These two approaches yield different empirical specifications for the private sector consumption function, and, on that basis, I designed empirical tests to discriminate between them. The structure of the tests involves estimating "augmented" specifications that nest both approaches as special cases. The results from these augmented specifications were empirically indistinguishable from those obtained under the consolidated approach, with formal tests providing decisive

rejection of the standard approach. Finally, I presented some evidence of the differing effects of the consumption and investment components of government spending implied by the consolidated approach.

DATA APPENDIX

The following abbreviations are used in this Appendix: Economic Report of the Presi- dent (ERP); Historical Statistics of the United States, Colonial Times to 1970 (HS); Na- tional Income and Product Accounts of the United States, 1929-76 (NIPA); Survey of Current Business (SCB).

The primary data series used in this paper are

POP,= Total Population 1929-76 [ERP, p. 265, Table B-28, first data column; and HS, p. 8, Series A7].

PNNP,= Implicit Price Deflator for Net National Product 1929-76 [NIPA, pp. 331-32, Table 7.5, line 3].

NNPRt =Net National Product in billions of 1972 dollars 1929-76 [NIPA, p. 28, Table 1.8, line 31.

CNDRt= Personal Consumption Expendi- ture on Nondurable Goods in billions of 1972 dollars 1929-76 [NIPA, pp. 6-7, Table 1.2, line 4].

CSRt= Personal Consumption Expendi- tures on Services in billions of 1972 dollars 1929-76 [NIPA, pp. 6-7, Table 1.2, line 5].

GSRt Government Purchases of Goods and Services in billions of 1972 dollars 1929-76 [NIPA, pp. 6-7, Table 1.2, line 21].

DXN,= National Defense Expenditures in billions of current dollars 1929-76 [NIPA, pp. 6-7, Table 1.1, line 23].

PFGS, = Implicit Price Deflator for Federal Government Purchases of Goods and Services 1929-76 [NIPA, pp. 318-19, Table 7.1, line 20].

TXNt = Total Government Receipts in billions of current dollars 1929-76 [NIPA, pp. 120-21, Table 3.1, line 1].

GXNt= Total Government Expenditures in billions of current dollars 1929

41In contrast to the earlier results, those reported in Table 6 for the coefficients of GC, and GI, are not very robust (DX, is quite robust, however). For example, if the war years 1941-46 are excluded, one can no longer reject a22 = a23 even at the 20 percent level, but a22 =

a23 = 0 can be rejected in favor of a22 = a23 < 0. Not too surprisingly perhaps, GC, and GI, underwent their greatest variation during 1941-46. Thus, if, in fact, GC, and GI, are subject to considerable measurement error, including the period of greatest variation in the data may be necessary to overcome such a problem. How- ever, since measurement error may have been correspondingly greater during 1941-46, the results should be taken as suggestive. Finally, when 1941-46 is excluded, a2l = a22 = a22 cannot be rejected. One possible interpretation of such a result is that one cannot reject the hypothesis that over the period 1930-40/47-76 all government spending was dissipative.




-76 [NIPA, pp. 120-21, Table 3.1, line 6].

TRN=Total Government Transfer Pay- ments to Persons in billions of current dollars 1929-76 [NIPA, pp. 120-21, Table 3.1, line 11].

GINTN =Total Government Interest Paid to Persons and Business less Divi- dends Received by Government in billions of current dollars 1929-76 [NIPA, pp. 120-21, Table 3.1, line 15 minus line 16 minus line 18].

REN =Undistributed Corporate Profits (Retained Earnings) with Inven- tory Valuation and Capital Con- sumption Adjustments in billions of current dollars 1929-76 [NIPA, pp. 195-96, Table 5.1, line 4].

GIRT =Total Govemment Gross Fixed Capital Formation in billions of 1972 dollars 1929-76 [SCB, March 1980, p. 41, Table 8, tenth column of data].

DURR =Total Net Stock of Durable Goods Owned by Consumers in billions of 1972 dollars 1929-76 beginning of period [SCB, March 1979, p. 24, Table 4, first column of data; and SCB, Aug. 1979, p. 61, Table 4, first column of data].

WNIt Total Private National Wealth in Current Prices in billions of dollars 1929-46 beginning of period [Goldsmith, 1956, pp. 14-15, Ta- ble W-1, col. 1 minus col. 9 minus col. 17 minus col. 24].

WN2 =Total Private National Wealth in Current Prices in billions of dollars 1947-59 beginning of period [HS, p. 255, series F422 minus series F429 minus series F437 minus series F444].

WN3 =Total Private National Wealth in Current Prices in billions of dollars 1960-69 beginning of period [HS, p. 252, series F349 minus series F353 minus series F361 minus series F364].

KN, =Total Net Stock of Fixed Nonresi- dential plus Residential Private Capital in billions of current dollars 1929-76 beginning of period

[SCB, Feb. 1981, p. 58, Table 2, first column of data plus p. 62, Table 6, second column of data].

HN,=Net Stock of Human Capital in Education and Training in billions of current dollars 1930-69 beginning of year [Kendrick, 1976, pp. 204-05, Table B-20, fourth column of data].

GBN,= Market Value of Total Govern- ment Debt Outstanding Held by the Public in billions of dollars 1929-76 beginning of period [Seater, 1981, pp. 90-91, Table 1, column labelled MVTOTOG1].

The following transformations of the above data were used to generate the variables used in the empirical section of the paper:

1) PCt = (CDR, + CSRt +.3 x DURR, +.1 x CDL)/POP,.

2) Y, = NNPR,/POP,. 3) GS,=GSR,/POP,. 4) TR, = TRN,(PNNP, x POP,). 5) TX, = TXN,/(PNNP, x POP,). 6) SUR, = (TXN - GXN,)/(PNNP, x

POP,). 7) RE, = RENt J(PNNP, x POP,). 8) GINT, = GINTNt /(PNNP, x POP,). 9) GBt = GBN,/(.5 X PNNPt x POPt +.5

x PNNP,1 X POP,t1). 10) GIt = GIR,/POP,. 11) DX, = DXNt(PFGS, x POP,). 12) Wt = WN,/(.5 x PNNP, x POP, +.5 x

PNNP,t1 X POPt-1) where

WNt = WN1t + HN, t =1929-46;

= WN2, + HN, t =1947-59;

= WN3,- (WN21959/WN31959) + HNt

t= 1960-69;

= KNt - (WN1969/KN1969) t = 1970-76.

13) K,= KN /(.5 x PNNP, x POP +.5 x PNNP,_1 X POP,-1).

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government debt, government spending, and private sector behavior

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