Private and government consumption with liquidity constraints

Economic theory predicts that liquidity constraints and substitutability or complementarity between private and government consumption result in excess sensitivity of private consumption to income and government consumption, respectively. Using annual data, we estimate these excess sensitivity parameters for each of 54 countries and show that they not only have sensible values but are also correlated with several variables in ways consistent with economic theory. Our findings imply that the degree of substitutability between government services and private consumption depends negatively on the fraction of government spending that goes to national defense. We also find that liquidity constraints typically exist and they are affected positively by output variability and negatively by the saving rate. Copyright (C) 1996 Elsevier Science Lid.