DP17433 The Long-Run Effects of Government Spending
We study the dynamic effects of military spending and other government outlays using 125 years of U.S. quarterly data and Vector Auto Regressions (VAR) with up to sixty lags. The output multiplier is below one at business-cycle frequencies but is above one in the long-run. A public spending expansion of 1% of GDP leads to a sustained increase in inflation of 0.15% per year. Military spending crowds out private investment over the first four years but crowds it in at longer horizons. Over the medium-term, innovation and productivity rise persistently, leading to a second output expansion. We show that these dynamics are most likely driven by government R&D expenditure rather than by public investment or public consumption, highlighting an important channel through which fiscal policy can support economic growth beyond the business-cycle.