Government Expenditure and Economic Growth: A Demand-side Analysis

In a post-Keynesian growth model with positive saving propensity out of wages, in this paper we analyze the implication of different kinds of government expenditures on aggregate demand and economic growth. We distinguish government expenditure into consumption and investment expenditure. The basic idea is that certain kind of government investment expenditure influences labour productivity. In a formal model we incorporate this idea by assuming labour productivity as an increasing function of government investment expenditure. When the economy is in an exhilarationist regime, under the balanced budget assumption, we show that a shift in government expenditure from consumption to investment purposes leads to an unambiguous rise in both aggregate demand and economic growth. However the result is ambiguous in the stagnationist regime. Once the balanced budget assumption is dropped, while in a stagnationist regime a rise in government investment expenditure may decrease aggregate demand and growth, it unambiguously raises both aggregate demand and growth rate in an exhilarationist regime. On the other hand, in the absence of balanced budget assumption, a rise in government consumption expenditure has positive effect on both the regimes . We also show that allowing the government to run into deficit and incur in debt does not necessarily lead to the public debt to rise without bound.