The Impact of Government Spending on Private Spending in a Two-Sector Economy

Abstract

Based on evidence that the dynamics of private spending on durables seem to differ from that of nondurables and services, this article disaggregates the impact of an exogenous government shock into its effect on each type of consumption good. Different calibrations of a dynamic stochastic general equilibrium (DSGE) model suggest that increases in government spending crowd out private spending on durable goods, while they serve to expand nondurable and services spending. Vector autoregression (VAR) estimates across these sectors yield qualitatively similar results. The estimated responses are driven by a negative correlation between durable spending and two measures of government spending that has not greatly varied over time—whereas the correlation between nondurable spending and government consumption has remained consistently positive throughout the sample. Estimates are consistent with a Great Moderation in three components of consumption, whereas moderations in the volatility of government spending took place earlier than the 1980s. The Great Recession of 2008–2009 saw an increase in volatility of consumption spending with no similar increases in the uncertainty of government spending.