A new paper by economist Valerie Ramey of University of California–San Diego looks at the impact of increased government spending on private activity and employment. Here is what she finds:
Can an increase in government spending stimulate the economy in a way that raises private spending?
Ramey finds that in most cases, private spending falls significantly in response to an increase in government spending. She finds that in general the multiplier is less than 1. However, she also warns that these results may not be necessarily applicable to the current debate, since part of the increase in government spending is financed by an increase in tax rates.
Can an increase in government spending raise employment and lower unemployment?
Her works shows that increase in government spending lowers unemployment, but only because in most cases it increases government employment. She writes:
However, I find the surprising result that in the great majority of time periods and specifications, all ofthe increase in employment after a positive shock to government spending is due to an increase in government employment, not private employment. There is only one exception. These results suggest that the employment effects of government spending work through the direct hiring of workers, not stimulating the private sector to hire more workers.
Ramey’s work on the impact of government spending on the private sector and employment is consistent with the work of many other economists. For a fascinating and balanced discussion about the impact of government spending on the economy and more, I would recommend listening to this interview of Ramey by George Mason University’s Russ Roberts.