Fiscal Policy and Consumption: New Evidence from the United States

Abstract

In this paper we estimate the marginal rate of substitution between aggregate per-capita consumption and per-capita government expenditure on goods and services using U.S. quarterly data over the period 1953 to 1993. This estimate is an important input to any attempt to assess the overall effectiveness of fiscal policy. Other recent consumption studies which incorporate the effects of government expenditure have failed to establish a stable estimate of the marginal rate of substitution. We argue that this failure results from imposing the unrealistic assumption that this parameter is constant. In contrast, we allow themarginal rate of substitution to depend on both the level and composition of government spending and provide strong econometric evidence in support of this claim.

JEL Classification: E21, E62