Cyclical Government Spending : Theory and Empirics

Abstract

<jats:title>Abstract</jats:title> <jats:p>This paper shows that part of what is usually labelled discretionary government spending actually varies systematically over the cycle. I exploit the pervasive gap between OLS and 2SLS local government spending multipliers to estimate how cyclical the systematic part of government spending is. Estimating a structural open economy New Keynesian model on U.S. state level data, I find that when employment decreases by $1\%$, the systematic component of government spending decreases by $0.23\%$. I also find that the empirical specification in Nakamura &amp; Steinsson (2014) does a good job in recovering the true impact multiplier effect, but that it overestimates the long-run cumulative effect.</jats:p>