EMPLOYMENT AND OUTPUT EFFECTS OF GOVERNMENT SPENDING - IS GOVERNMENT SIZE IMPORTANT

The effects of government spending on employment and output may depend on government size and the persistence of spending. The empirical results suggest that permanent (or persistent) changes in government consumption have a greater impact an output and employment than temporary (or cyclical) changes. This implies a negative wealth effect and reduces the stabilization potency of government spending. The findings also support the hypothesis that the output elasticity of government consumption is positive but declines with increases in government size. Using the estimated equations, I calculate the optimal government size for the representative country as around 20 percent of GDP.