Output Response to Government Spending: Evidence from New International Military Spending Data

Fiscal policy, among other measures, was widely used to stimulate employment and to put the U.S. economy back on track in response to the Great Recession and in a number of previous recessions in both the United States and in Europe. It is striking how much disagreement there was ? and still is ? among policymakers and academics alike about the inner workings of fiscal policy and its effect on output and employment. Estimating fiscal multipliers is methodologically challenging, as government spending often reacts to current or anticipated changes in economic conditions, and requires bold identifying assumptions. Barro (1981), Hall (1986, 2009), Rotemberg and Woodford (1992), and Barro and Redlick (2011), among others, rely on military spending as an exogenous component of government expenditure. However, in the United States after World War II (and even more so after the Korean War), there has not been enough variation in military spending to estimate the multiplier with a high degree of precision. This paper uses data from a large panel of countries with significant time variation in military spending to shed light on the magnitude of the government spending multiplier.