Government Employment Expenditure and the Effects of Fiscal Policy Shocks

Since World War II, about 75 percent of consumption expenditure by the U.S. government has consisted of wages and salaries for government employees. I distinguish between the goods and the employment expenditure components of government consumption in assessing the effects of fiscal shocks on the macroeconomy. Identifying exogenous fiscal shocks with the onset of military buildups, I show that they lead to a substantial increase in both the number of hours worked and output for the government. I also show that allowing for the distinction between the two main components of government consumption improves the quantitative performance of the neoclassical growth model. In particular, a neoclassical model economy with government employment does a good job of accounting for the dynamic response of private consumption to a fiscal policy shock. Government employment expenditure acts as a transfer payment for households, thereby dampening substantially the wealth effect on consumption and labor supply associated with fiscal shocks.