Chapter 12 The Effect of Government Purchases In this chapter we consider how governmental purchases of goods and services affect the economy. Governments tend to spend money on two things: wars and social services. Barro’s Figure shows that expenditures by the . | Chapter 12 The Effect of Government Purchases In this chapter we consider how governmental purchases of goods and services affect the economy. Governments tend to spend money on two things wars and social services. Barro s Figure shows that expenditures by the . government have comprised a generally increasing fraction of GNP since 1928 but even today that fraction is nowhere near the peak it attained during WWII. This pattern is generally repeated across countries. The taste for social services seems to increase with national wealth so the governments of richer countries tend to spend more as a fraction of GDP than the governments of poorer countries especially during peacetime. Of course there are exceptions to this pattern. We will examine government spending in three ways 1. We shall consider the effect of permanent changes in government spending in order to think about the secular peacetime increases in spending 2. We shall consider temporary changes in government spending in order to think about the effect of sudden spikes like wars 3. We shall begin an analysis of the effect of government social programs. Since government social programs unemployment insurance social security systems are inextricably linked to tax systems we will defer part of our analysis to the next chapter. Since we have yet to fully discuss tax policy for this chapter we will assume that the government levies a very special kind of tax a lump-sum tax. That is the government announces a spending plan and then simply removes that amount of money from the budget of the representative household. As we shall see in the next chapter this kind of tax system does not distort the household s choices. 112 The Effect of Government Purchases In the Barro textbook the government budget constraint in addition to lump sum taxes also contains fiat currency. In this chapter we will assume that the government does not use the printing press to finance its purchases. In later chapters especially .
