Composition Gov Expenditure

JOURNAL OF
Journal
ELSEVIER
Economic
?Ynamics
& control
of Economic Dynamics and Control

19 (1995) 747-m786
The composition of government expenditure and its

consequences for macroeconomic performance*
Stephen
J. Turnovsky*-a,
Walter
H. Fisherb
aDepartment of Economics, University of Washington, Seattle, WA 98195, USA

b Department of Economics, Kansas State University, Manhattan, KS 66506, USA
(Received
May 1993; final version
received
January
1994)
Abstract
This paper employs the intertemporal optimizing market-clearing framework to compare the effects of government consumption expenditure and government infrastructure
expenditure on macroeconomic adjustment and performance. Particular attention is
focused on the time path of the capital stock and its adjustment to both permanent and
temporary changes in government expenditure are considered. We show how the effects
of both forms of government expenditure on economic welfare can be broken down into:
(i) a direct crowding-out effect and (ii) a second component which describes the intertemporal tradeoffs between the short-run rate of capital accumulation and the resulting
change in the capital stock.
Key words:
Government consumption;
E62; H53
Infrastructure;
Capital; Welfare
JEL classification:
1. Introduction
The effects of government expenditure on aggregate economic activity is

a subject with a long and controversial history. The focus of this issue has shifted
*Corresponding
author.
This paper has been previously presented at the April 1993 Conference on Monetary Policy held at
the Federal Reserve Bank of Kansas City. We are grateful to participants
of the conference, and in
particular to Robert Chirinko and Narayana
Kotcherlakota
for their comments. The paper has also
benefited from the comments of Stephen Ferris and of two anonymous
referees.
0165-1889/95/$9.50
CI 1995 Elsevier Science B.V. All rights reserved
SSDI 016518899400803
P
748 S.J. Turnovsky,
W.H. Fisher/Journal
of Economic Dynamics and Control 19 (1995) 747-786
as specific economic problems have become more prominent. A central concern

in traditional discussions of this issue, which were typically based on Keynesian
type aggregate demand models, was whether government expenditure could
serve as an effective policy tool in mitigating the size of business cycle fluctuations. Related to this issue was the question of whether, and to what extent,
public expenditure crowds out private activity.2 More recently, and coinciding
with the occurrence of large United States budget deficits, economists have been
analyzing whether financing a given path of government expenditure using
different intertemporally sustainable paths of debt and taxes has important real
effects.3
Another issue which is of current concern, one which is the chief focus of this
paper, is the effect of government expenditure on growth, productivity, and
overall economic welfare. There are several reasons for being interested in this
line of inquiry. For one, the end of the cold war is causing major fiscal
adjustments in the United States and in many other industrialized economies.
The ongoing debate on whether or not to allocate the resulting peace dividend
to social programs or to the rebuilding of domestic infrastructure highlights the
importance of the composition of government expenditure as both a political and
economic issue. Furthermore, the issue of the influence which each type of
government expenditure has on long-term productivity and growth has been
particularly pressing as economists have sought to find explanations for the
slowdown in productivity growth that has occurred throughout the developed
world.
The role of infrastructure expenditure in generating productivity growth has
drawn the most attention, particularly since the work of Aschauer (1989,1990),
whose striking results implied that the output elasticity of public capital in the
United States during the 1949-85 period equalled 0.39 and that 80% of the
decline in productivity growth since the early 1970s is attributable to the decline
in the growth of public capital over the same time.4 Subsequent studies have
yielded mixed results, with some finding a negligible role for public capital in
promoting productivity growth, while others showing a significant role, although not generally as great as that implied by Aschauers results. Research
which falls into the former category includes Aaron (1990) and Tatom (1991),
See Blinder and Solow (1973) and Turnovsky

(1977) for dynamic extensions
framework which emphasize the role of asset accumulation
over time.
of the Keynesian
Spencer and Yohe (1970) and Buiter (1977), as well as others, have argued that crowding
take place on a variety of margins both at a point in time and intertemporally.
3 Blanchards
this area.
4Barro
(1985) overlapping
(1990,199l)
generations
finds that government
macroeconomic
consumption
model is a good example
expenditure
towers growth
out can
of work in
and investment.
S.J. Turnovsb,
W.H. Fisher/Journal
of Economic Dynamics and Control 19 (1995)
747-786
749
who criticize Aschauer largely on the grounds of econometric method.5 By contrast,

Lynde and Richmond (1993), Fernald (1993), and Finn (1993) address some of these
criticisms and yield results which are more supportive of the overall Aschauer view.j
While most economists would agree that public capital is an important determinant
of aggregate production, to determine the magnitude of its contribution to output
depends upon finding the proper procedure for estimating long-run relationships
between nonstationary time series, an issue which remains unsettled,
At an analytical level, one can usefully distinguish between government
expenditure which provides direct utility to households, on the one hand, and
government expenditure which raises the productive capacity of firms, on the
other. The former, which we shall refer to as government consumption expenditure, includes such things as expenditures on national defense, national parks,
and various social programs. The latter category, which includes expenditures
on roads, bridges, education, and job training, we shall classify as gooernment
ir$atrucrure
expenditure. Because these two kinds of government expenditure
have distinct impacts on preferences and technology, a shift in the composition
of government expenditure can have a significant impact on such key macroeconomic variables as the rate of capital accumulation, work effort, and overall
household welfare. The major contribution of this paper is to present a detailed
analysis of the macroeconomic consequences of these two types of government
expenditure, using a general neoclassical intertemporal optimizing framework.
Recent theoretical work analyzing the macroeconomic consequences of fiscal
policy has been dominated by the neoclassical framework, based on individual
optimization and market clearing; see, e.g., Barro (1981,1989,1990), Barro and
King (1984) Aschauer (1988) Aschauer and Greenwood (1985) and Baxter and
King (1993). These authors consider the real effects of government expenditure
apart from any additional effects the method of financing that expenditure
might have, an approach we will follow. In addition to incorporating, through
the budget constraint, the standard negative effect of government expenditure
Specifically,
Aaron (1990) and Tatom (1991) point out that Aschauers estimates of the productivity
of public capital are sensitive to the inclusion of other dependent variables, such as energy prices, as
well as to the specification
endogeneity
Both
Fernald
Fernalds,
of trend. They further
(1993)
and Finn
using a procedure
roads are highly productive,

around
(1993)
with equations
focus on the productivity
with output
elasticities, depending
the standard
production
derived from an intertemporal
generalized method of moments estimation procedure.

capital
equals 0.16, but she notes that
techniques for estimating

about 0.20.
that his results are biased due to the
that corrects for the endogeneity
0.10 to 0.30. Finn augments
researcher
contend
of public capital.
road capital.
upon specification,
function
optimizing
approach
framework
Lynde
and Richmond
finds that
ranging from
used by other
and employs the
Her point estimate for the elasticity
it is imprecise.
models with nonstationary
of government
of public infrastructure,
(1993),
ofpublic
who use
variables, find an average output elasticity of
150 S.J. Turnovsky
W.H. Fisher/Journal
on household wealth, most of these authors allow government expenditure to

impact directly on household utility and production. We will extend this work by
adopting a more general framework than do these authors, who often specify the
influence of government expenditure on preferences and technology in a somewhat restrictive way. Specifically, we permit government consumption expenditure to substitute for, or be complementary to, private consumption and work
effort. Similarly, we allow government infrastructure expenditure to have a variable marginal physical product, and more importantly, to impact on the marginal
physical productivities of the private factors of production, capital, and labor.
This less restrictive framework leads to more general relationships for the effect of
government expenditure on variables such as the long-run capital stock.
In employing the intertemporal optimizing representative agent model, our
emphasis is on characterizing the general macrodynamic adjustments following
changes in the composition of government expenditure.* We focus particularly
on two aspects. The first is on the intertemporal adjustment in the capital stock.
Secondly, and more importantly, we compare the consequences of the two types
of government expenditure on economic welfare. The intertemporal optimizing
framework is a very natural one within which to address this issue, since the
utility level of the representative agent provides an appropriate criterion for
assessing the overall benefits of such policy shocks. Because of the gradual
adjustment of the capital stock, the effects of government policy are spread over
time. We therefore discuss the effects of these expenditure changes on the entire
time path of instantaneous utility, as well as on the overall accumulated level of
welfare. In the process we emphasize how government expenditure involves an
intertemporal tradeoff in welfare, one which differs for each type of government
expenditure. For instance, we show that if (as seems likely) government infrastructure expenditure has a greater effect on the long-run capital stock than does
government consumption expenditure, then it will lead to a more pronounced
tradeoff in intertemporal welfare. This is due to the fact that in this case
infrastructure expenditure generates a higher rate of capital accumulation
which, while it tends to reduce consumption and depress welfare in the short
For example, originating

with the early work by Bailey (1971), government
consumption
is often
modeled as a partial substitute for private consumption;
see, e.g., Barro (1989) and Aschauer (I 988).
While some empirical evidence supports this assumption,
e.g., Kormendi (1983) estimates that each
unit increase in government expenditure reduces private consumption
by around 0.2, it does rule out
the case where government
expenditure
enhances the utility of private consumption.
In order to
focus on the expositional
aspects of his model, Aschauer (1988) restricts the marginal
physical
product of public inputs to be constant.
*Baxter and King (1993) derive the transitional
dynamic response of output, investment, consumption, and employment
to shocks in the composition
ofgovernment
expenditure by calibrating a real
business cycle model. We do not employ such numerical
analysis, since we can solve for the
qualitative dynamics of the macroeconomy
in our general framework.
S.J. Turnovs~,
W.H. Fisher/Journal
751
run, will ultimately lead to more output, greater consumption, and therefore
higher welfare in the long run.
The effects of both permanent and temporary changes in government expenditure on consumption and infrastructure are examined. The analysis of temporary shocks is of interest for at least two reasons. First, as will become evident in
due course, the differences between the effects of the two types of government
expenditures tend to be sharpened in the case of temporary shocks. Secondly,
some of the current proposals to improve the current state of the US. economy
call specifically for temporary increases in different types of expenditure.
The remainder of the paper proceeds as follows. Section 2 sets out the
structure of the macroeconomic equilibrium. Section 3 describes the effects of
increases in government consumption and infrastructure expenditure on the
steady state of the macroeconomy. Section 4 analyzes the effects that permanent
increases in government consumption and infrastructure expenditure have on
the transitional dynamics of capital accumulation and the marginal utility of
wealth, while Section 5 considers their effects on welfare. Section 6 compares the
impact that temporary increases in the two types of government expenditure
have on the economys transitional dynamics, while Section 7 analyzes their
contrasting effects on welfare. Conclusions are briefly outlined in Section 8.
Finally, some technical details are contained in an Appendix.
2. The framework and macroeconomic
equilibrium
Since we are interested in focusing on the real effects of government consumption and infrastructure expenditure, we exclude money, thereby abstracting
from any nominal effects these fiscal shocks might have. It is convenient to
consolidate the household and productive sectors of the economy. Consequently, the economy is modeled as a representative worker-entrepreneur with
an infinite planning horizon, facing perfect capital markets, and having perfect
foresight. The representative agent can thus be postulated as choosing private
91n our analysis of the temporary

case, we will hold the level of employment
restrictive than it seems, because, as we will show, both kinds of government
a similar impact, through the wealth effect, on employment.
fixed. This is less

empenditure have
The characterization
of this type of model as one embodying perfect foresight, while common in
the literature,
is somewhat
inaccurate.
The reason is that we will be introducing
unanticipated
shocks, which under strict perfect foresight would have been foreseen. This observation,
which is
often made in this regard, is largely a semantic one. Operationally,
the assumption
of perfect
foresight, as we are using it, pertains to a consideration
of the forward-looking
solution to the
dynamic system describing the economy. It does not require that discrete unanticipated
exogenous
events be exactly predicted; indeed, by their nature, they typically will not be. For this reason, our
model can more accurately
be called one of quasi-perfect
foresight. Agents acts as if they have
perfect foresight, even though they get surprises when discrete structural
changes occur.
152 S.J. Turnovs~,
W.H. Fisher/Journal
consumption, c, labor supply, 1, capital stock,

bonds, b, in order to maximizei
k,
and holdings of government
co
U(c 79
1 gC)e-@dt ,
u,
>
0,
u,,
<
0,
u,
>
0,
u,,
<
0,
u1
<
0,
u,,
<
0,
(14
subject to the budget constraint

c+ i + 6=
F(k,
I,g,)
+ rb -
(lb)
and initial conditions

b(0) = bo,
k(0)
= ko,
(lc)
where gC= real government consumption expenditure, g1 = real government

infrastructure expenditure, r = real lump-sum taxes, #I = rate of consumer time
preference, taken to be constant, and r = short (instantaneous) real interest rate.
The instantaneous utility function U is assumed to be strictly concave in
private consumption, leisure, and government consumption expenditure. In
addition, we postulate private consumption and leisure to be normal goods. We
do not, however, restrict the way in which government consumption expenditure impacts on the marginal utility of private consumption and disutility of
work effort, as measured by the partial derivatives U,, and U,,. Output is
produced by a neoclassical production function exhibiting positive, but diminishing, marginal physical productivity in all factors, y = F(k,l,g,),
Fk > 0,
Fkk c 0, Ft > 0, Ft, < 0, F, > 0, F,, < 0. In addition, it is assumed to be linearly
homogeneous in the private factors, capital and labor, implying that Fkt > 0.12
At this point we do not impose restrictions on the cross partial derivatives,
Fkg and Ft,, so that in principle government infrastructure expenditure can be
either a complement or a substitute for capital or labor in production. However,
we should observe that the assumption of homogeneity of the production
function in the two private factors imposes the constraint
F, =
Fk,k + F,,I,
We adopt the following notation. Partial derivatives are indicated by corresponding

subscripts.
Time derivatives are denoted by dots. To conserve notation, we write the first, second, and cross
partials of the utility function U with respect to ge as U,, U,,, U,, and U,,. Similarly, we write
the first, second, and cross partials of the production
function F with respect to 9, as F,, F,,, Fk,,
and Fr,.
*Linear
homogeneity
~MFU = F$, FuJ,
in the
private
- FHFI = FrAyll),
factors,
and F&r
k and
1, implies
- FI#~ = F&/O.
the
following
relationships:
S.J. Turnovsky, W.H. Fisher/Journal
747-786
753
so that our assumption F, > 0 implies that both Fkg < 0 and F1, < 0 cannot
hold simultaneously.
Differences in our formulation of how government expenditure impacts on
production from other specifications merit further comment. For example,
Aschauer (1988) does not restrict the sign of the marginal productivity of public
inputs, with F, < 0 referring to government regulations, which inhibit productivity. This contrasts with our focus on F, as reflecting infrastructure, with its
presumed positive effects on total output. Secondly, our assumption of linear
homogeneity in the two private factors views infrastructure as providing economies of scale in production. An alternative assumption discussed by Aschauer
(1989) is to assume that the production function is linearly homogeneous in all
three factors of production. 3 It turns out that the choice between these two
alternative formulations makes little difference, as long as one assumes F,, > 0
in this alternative specification.
Note that our specification assumes that it is the currentJlows of government
consumption and infrastructure expenditure, rather than the services of the
existing stocks of government consumption and infrastructure, which generate
additions to utility and production. In adopting this specification, we follow
most of the recent work in this area. An alternative approach would be to allow
the government also to accumulate stocks of durable consumption goods and
physical infrastructure capital. This formulation has much to recommend it in
terms of added realism, in that many utility-enhancing public goods, such as
national parks, and production-enhancing
public goods, such as roads, are
likely to impact on the economy through their accumulated stocks, rather than
their current flows. However, this approach would substantially increase the
dimensionality of the dynamic system and considerably complicate the subsequent analysis, without yielding clearcut gains. Because of the additional
sluggishness this would introduce into the system, some of the results pertaining
to the short run, and especially the response to temporary fiscal disturbances,
would be affected by this alternative formulation. But by contrast, since in the
long run, expenditure flows consist of depreciation expenditures which tend to
be proportional to stocks, our steady-state results are much less sensitive to this
specification. Thus, on balance, we feel that our current framework, which treats
both types of government expenditures as flows, is sufficiently general to capture
the salient distinctions between the two types of public goods.
All investment (or disinvestment which is also assumed to be feasible) occurs
at a continuous rate and does not incur adjustment costs.14 In making his
utility-maximizing decisions, the representative agent takes r, /?. and r as given.
ISThe same assumption

14We do, however,
is made by Barro (1990) in his analysis
impose
the constraint
k z 0.
of endogenous
growth.
154
747-786
The consumption and production decisions made by the agent lead to the
following first-order optimality conditions:
UC@,
1,SC)= 1,
(24
U,(GLSC)= - Fdk, 1,s,)k
P-3
lF,(k, l,g,) = - j + l/I,
(W
where A(t), the costate variable associated with the budget constraint (lb), is the
marginal utility of wealth. In addition, the following transversality conditions
must be met:
lim klem8 = 0 3
(W
lim bAe_@= 0,
,+oD
(2f)
t-cc
thereby ruling out explosive equilibria. While 1 may undergo an initial jump at
time 0, when new information becomes available, thereafter it must evolve
continuously along with k.
The government budget constraint links the accumulation of government
debt to the expenditure and taxation decisions of the fiscal authorities,
6 = gc + gr +
rb -
(3)
5.
This equation is standard, the only difference being that the government may
now spend its lump-sum tax revenues on two types of goods, consumption and
infrastructure. Combining the short-run budget constraint (3) with the transversality condition (2f) leads to the intertemporal government budget constraint,
bo +
sa
0
Csc+
sI -
t(s)1
ev (-jlr(f)d+ds=O.
This requires that the initial stock of government bonds b. plus the present
value of subsequent deficits gE + gI - r(s), discounted at the appropriate
variable interest rate, must sum to zero. Since the focus of our analysis is on
the composition of government expenditure, rather than the way it is financed,
we shall simply assume that the fiscal authorities choose to support their
S.J. Turnovsb,
W.H. FisherJJournal
155
expenditures by setting lump sum taxes in any one of the infinite number of ways
consistent with (3).rs We therefore do not address issues of sustainability of the
deficit, discussed by McCallum (1984) and others.
Finally, substituting Eq. (3) into the budget constraint faced by the representative agent yields the market-clearing condition for output,
F(k,l,g,)
= c+
k + gc +
gr.
(4)
This completes the description of the economy, from which the macroeconomic equilibrium can be derived as follows. First Eqs. (2a) and (2b) can be
solved for c and 1 in the form:
<o, ck <
0, cg,> 0, cy,> 0,
c = c(A,k,g,,g,),
cd
1= 64 k sc,sIh
11> 0, lk > 0, 1, > 0, I,, > 0.
(54
(5b)
The partial derivatives of private consumption demand and labor supply are
found by differentiating the first-order conditions (2a) and (2b) with respect to 2,
k, gc, and gr. (The actual expressions are reported in the Appendix.) The signs of
cL and lA follow from normality, while ck and lk follow from assumptions on the
utility function and production function. The partial effects of the two types of
government expenditure depend more precisely upon how they interact with the
private decisions pertaining to utility and production. Combining (2~) and (2d),
we obtain the equality between the short-term interest rate and the marginal
physical product of capital
(54
r = F,(k 1,SI).
The dynamics of the economy are obtained by substituting the short-run

solutions for c and 1, presented in (5a) and (5b), into the product market clearing
condition (4) and the first-order condition for the capital stock (2~) rewriting
these relations as
i =
F(kW,k,g,,g,),g,) - cG,k,g,,g~) - gc - gr,
(64
i =
iCB - Fk(k,l(~,k,g,,g,),g,)l.
(6b)
Eqs. (6) comprise an autonomous dynamic system which jointly determines

the intertemporal evolution of k and il and hence of the macroeconomy
as a whole.
That
is, Ricardian
equivalence
is assumed to hold.
756 S.J. Turnovsky, W.H. Fisher/Journal
of EconomicDynamics and Control 19 (1995) 747-786
The steady state of the economy, reached when k = 1 = 0, is obtained from

the equations
(74
where I? and 1 denote steady state values. Eq. (7a) describes the steady-state
equilibrium in the product market when investment is zero, while Eq. (7b) states
that in the long run the marginal physical product of capital is constrained to
equal the fixed time rate of prefere_nce. Together, the steady-state conditions (7)
determine the steady-state values k and I implied by specified levels of government consumption and infrastructure expenditure, qc and gr. Because of the
homogeneity of F, (7b) determines the long-run capital-labor ratio. From this
relationship one sees that an important distinction between the long-run effects
of government consumption and infrastructure expenditure is, while the steadystate capital-labor ratio is independent of the level of gE, it does depend on the
level of qr.
Linearizing the system (6aH6b) about the stationary equilibrium (7aH7b),
corresponding to given initial levels of gCand gr, the dynamics can be approximated by the following matrix equation in k and i:
k-c
)(
L-X
u-9
>
Since A = dI1 f& - 812821 > 0, the eigenvalues of (8), cc1and p2, can be shown
to satisfy p1 < 0 and p2 > 0 and to satisfy the additional properties p2 > IpI 1
and p2 + fir = /?. The general form of the solution to (8) is given by
k = i +
A,el + AzeP2,
Xe,,
2=X-
Xe,,
16The signs of II,,

short-run
responses
+ pl
Altin
Pa)
-
Q2,
A2eP2,
Pb)
Xb2 + p2
, 012,and Oz2 follow directly from the signs of the partial derivatives
(5a)-(5b).
The sign of 0 *I is determined
by substituting
of the
& and evaluating.
751
and the equilibrium is therefore a saddlepoint, with the constants Ai being

determined by the appropriate initial and terminal conditions on k and 2.
These boundary conditions depend on the duration of the fiscal shock, i.e.,
whether the shock is, for instance, permanent or temporary. The solution
obtained by setting AZ = 0 implies a stable adjustment path satisfying the
transversality
condition
(2e). Starting from k = ko, this is described
by
k = i + (k, - E)eP1,
(104
(lob)
and corresponds to the negatively sloped locus XX in Fig. la. As long as no

future shock is anticipated, the economy must lie on this stable locus in order for
the transversality condition to hold. Likewise, the solution for which AI = 0
implies a purely unstable trajectory given by
i-I=
(1Oc)
-(~eI;B:'112)(k-I;)=("2~2e11)(k-8,
This unstable locus, illustrated by Y Y in Fig. la, has positive slope, though
smaller in absolute value than that of the stable trajectory.
3. The long-run effects of government expenditure

Since the analysis is based on the assumption of perfect foresight, the
transitional adjustment is determined in part by expectations of the steady state.
It is therefore convenient to begin with a consideration of the long-run equilibrium effects of changes in the two types of government expenditure. The effects
of such changes on k and ;L are obtained by differentiating the steady state
system (7a) and (7b) with respect to gEand gf, respectively, and shall be discussed
in turn.
Because
pI is an eigenvalue
3.022 + 11 < 0.
of (8).
- %I,,/(xO,,
+ /A,) = (p, - O,,)/U,,,
which
implies
that
7%
S.J. Turnovsky,
W.H. Fisher/Journal
3.1. Increase in government
of Economic Dynamics and Control 19 (199s)
consumption
747-786
expenditure
The long-run effects of an increase in gCon k and 1 can be expressed in the

form:18
dk
-=-dgC
Bzz
A
[ 1
Uef;:Fk, d U,
dg, -U,
~- DA
(114
where
D = U,,( Utt+ IF,,) - U,,> 0.
The expressions in Eqs. (11) have been broken down into two sets of effects. The
first, given by the first term on the right-hand side of each equation, represents
what we refer to as the pure resource withdrawal effect, or wealth effect, of an
increase in gC.Secondly, the remaining terms represent the effect of an increase in
gCthrough its impact on the subjective evaluations of private consumption and
work effort.
The resource withdrawal effect tends to raise both the long-run capital stock
and the marginal utility of wealth. The intuition behind this result is that
because government consumption expenditure is not directly productive and
does not affect the marginal physical productivities of capital and labor, an
increase in ge (with its accompanying increase in taxes over time, see (3)) leads to
a less than proportional increase in output, dj/dgC < 1, and consequently to
a fall in private wealth and consumption. The marginal utility of wealth
therefore rises, inducing agents to increase their supply of labor. During the
transition to the new steady state, the increase in labor supply raises the
marginal physical product of capital above its (unchanged) long-run equilibrium
value, thereby encouraging capital accumulation until the capital-labor ratio is
restored to its original fixed equilibrium level, implied by (7b).
The degree of capital accumulation is, however, also influenced by the effect
which a long-run increase in government consumption expenditure has on the
marginal rate of substitution between private consumption and work effort
U,/UI. As is evident from Eq. (1 la), a rise in gCthat lowers the marginal rate of
substitution would reinforce the wealth effect just described and thus provide an
In evaluating the following steady-state

expressions, we make use of the constant
properties of the production
function described in Footnote
12.
returns
to scale
747-786
759
extra impetus to capital accumulation, due to the fact that a decline in the
marginal rate of substitution encourages greater employment, and therefore capital accumulation, by increasing the amount of private consumption that a representative agent is willing to forego to obtain a reduction
in work effort. By contrast, if a rise in gc raises the marginal rate of substitution, i.e., if it lowers the amount of private consumption that the agent is
willing to forego to obtain a reduction in work effort, then greater employment is discouraged and the positive impact of the resource withdrawal effect
on capital accumulation is lessened. In the Appendix we provide expressions
for the steady state changes in employment, private consumption, and output. These expressions are also in terms of the effect of gc on U,/U,, which
has the same qualitative impact on t t, and jj as it does on k:
Several special cases, when the expressions in (1 la) and (1 lb) simplify,
should be noted. First, if as is commonly asssumed, the utility function is
additively separable in c and 1 on the one hand, and in gE on the other, there
is no interaction between public consumption expenditure and private decisions, in which case these expressions reduce to just the resource withdrawal
effect. Secondly, the response of the capital stock continues to be given by
the resource withdrawal effect, if the utility function is multiplicatively
separable in c, I, and in gc, though in this case, the response of the marginal
utility of wealth will now depend upon the interaction of government consumption expenditure with the private decisions. Finally, as noted previously,
an important special case, familiar from the work of Barro (1981,1989),
Aschauer (1988), Christian0 and Eichenbaum (1992) and others, treats
preferences over consumption as preferences over a composite of private
and government consumption expenditures, i.e., V(c, I, gE) = V(c + clgc,I),
0 < a < 1, where the parameter a measures the degree of substitutability
between private and public consumption. Under this formulation, Eqs. (11)
reduce to
dc
dg,=
dX
-_=
dg,
&(l
-a)
A
(124
- &(I
A
- a)
(1-W
These expressions consist simply of the resource withdrawal effect scaled by

(1 - a). Clearly, the more closely public expenditure substitutes for private, i.e.,
the greater is a, the smaller is the decline in wealth and in the increase in its
marginal utility. As a result, the long-run increase in work effort and thus in the
capital stock is mitigated.
760 S.J. Turnovsky W.H. Fisher/Journal
3.2. Increase
in government
expenditure
on infrastructure
Turning to the effects on c and 2 of a permanent increase in government

infrastructure expenditure, differentiation of the steady-state system (7aH7b)
with respect to g1 yields
dX
-=-
&1(l - Fg)
dsr
(Fk
&Fkl)Fkg
(&c(?/~)
UdXFkkFlg
DA
Wb)
ParalleI to (1 l), these expressions consist of two effects. The first is the net
withdrawal effect, which is analogous to the previous expression, though it is
now scaled by the factor (1 - Fg). Secondly, the remaining terms reflect the
impact of directly productive government expenditure, gl, on the marginal
physical products of capital and labor.
An interesting feature of these expressions is that to the extent that infrastructure contributes directly to the production of output (i.e., F, > 0), it tends to
have a contractionary effect on the long-run capital stock. This is because as
long as expenditure on infrastructure contributes positively to output, it provides resource augmentation, rather than resource withdrawal. By the previous
argument, it therefore generates a positive wealth effect, a decline in the marginal utility of wealth, thereby reducing the labor supply, and the long-run stock
of capital. Taking this into account, the factor (1 - F,), which measures the
direct resource cost of a unit of infrastructure expenditure relative to its direct
benefit, thus measures the net resource withdrawal effect. Comparing this with
the corresponding expression in (1 la), it is seen that this component is less
expansionary than in the case of a rise in gc. In fact it will be contractionary if
F,> 1.
In the borderline case where the marginal product of infrastructure just equals
its resource cost, F, = 1, the net resource withdrawal effect is zero. Infrastructure expenditure then affects zand 1 only through its influence on the marginal
products of capital and labor. This is a particularly interesting case, because if
infrastructure expenditure is complementary to the private factors of production, Fkg > 0, Fig > 0, then work effort and capital accumulation will be encouraged, despite the fact that this influence also tends to raise private wealth and
hence to lower 1. The fiscal expenditure multiplier is greater than unity,
dJ/dg, > 1. Thus under these circumstances, an increase in gr raises private
IgThis observation
is also made by Aschauer
and Greenwood
(1985)
S.J. Turnowky,
W.H. Fisher/Journal
761
wealth and crowds-in private consumption in the long run. Indeed, the rise in
private wealth also tends to encourage the consumption of other private good,
leisure. This provides an off-setting influence to effect of FI, > 0 and implies that
the long-run response of employment to a rise in g, is ambiguous. These results
are shown in the Appendix and point out some of the important differences
between the effects of government consumption and infrastructure expenditure.
3.3. Comparative productive
efsects
An important issue in the debate pertaining to the composition of government

expenditure is whether a unit of output can be more productively allocated to
government consumption or to infrastructure. The relative effects of the two
types of expenditure on the long-run capital stock can be determined by
comparing (1 la) with (13a). Intuitively, one would expect expenditure on infrastructure to have the larger positive impact on the long-run capital stock. While
the influences determining the adjustments of capital are sufficiently complex to
prevent us from being able to conclude this unambiguously, under plausible
conditions, this in fact seems likely to be so. O We shall illustrate the comparison
by assuming that utility and production are of the multiplicatively separable
forms:
~(c,Lg,) = ~(c,l)W(g,),
F(k Lg,) = ff(k W(g,),
where the function Zf(k, I) is homogeneous of degree one, and the signs of the
various derivatives in these functions satisfy our previous assumptions. In this
case one can show that
dc
dg,
dk
- = GGHH,,(a - 1); - G$
dg,
+ GGH,,H,;,
where (Tis the elasticity of substitution in production. It thus follows immediately that a sufficient, but not necessary, condition for expenditure on infrastructure
to lead to a higher long-run capital stock than expenditure on consumption, is
that 0 > 1. This will therefore be the case if the production function is
Cobb-Douglas. Using the expressions in the Appendix a similar comparison
can be carried out for output, but this is not pursued.
One example where the reverse would occur is if the utility and production
functions were
additively separable in their respective components
of government
expenditure.
In this case both
(1 la) and (13a) would reduce just to their corresponding
resource withdrawal
effect, which as we
have seen is larger in the case of government
consumption
expenditure.
162 S.J. Turnovsky W.H. Fisher/Journal
K,
R,
)K
Fig. la. Expansion of government consumption expenditure.
4. The dynamics of permanent fiscal shocks

consumption expenditure
Fig. la illustrates the transitional adjustment of k and 1 following a permanent increase in government consumption expenditure. We will describe the case
in which both kand 1 rise in the steady state.l Let the economy begin at point
P, which represents initial equilibrium. The stable, XX, and unstable, YY,
adjustment loci, described by Eqs. (10a) and (lob) respectively, intersect at this
point. (To avoid cluttering Fig. la, the unstable locus corresponding to the
r In other words, we assume that even if the increase in gC raises the marginal rate of substitution
between private consumption and work effort, this negative influence on long-run capital accumulation is dominated by the positive influence of the resource withdrawal effect of greater government
expenditure.
163
initial equilibrium is not drawn.) A permanent increase in ge will increase the

long-run capital stock, k, and marginal utility of wealth, 1, and cause the
economy to eventually settle at a point such as Q, lying to the northeast of
the initial equilibrium. The corresponding movement in the stable and
unstable adjustment paths are to XX and Y Y, respectively. Since the
capital stock is constrained to adjust continuously, the entire burden of the
initial response to a permanent increase in gC falls on the marginal utility
of wealth, which jumps positively at t = 0. This movement in L(O) takes
the economy immediately to point A on the new stable locus XX. The rise
in A(?) reflects the fall in private wealth that the increase in government
consumption expenditure brings about. In response to the fall in wealth, the
representative agent takes less private consumption and increases labor
supply. This raises the marginal physical product of capital above its unchanged
steady-state value and thereby encourages capital accumulation, R > 0. With
the rate of return on capital greater than its steady-value, 2 -C0 in order for
the arbitrage condition (2~) to be met. Thus, after its jump to A, the economy
will move down XX, accumulating capital until the new steady state at Q
is reached.
We have seen the crucial role played by the labor supply in the dynamic
adjustment of the economy. We now consider what would happen if employment were held fixed. The steady-state optimality condition (7b) now implies
that the steady-state capital stock c (rather than the capital-labor ratio)
is determined by the fixed rate of time preference /1, together with gl, and is
independent of gE. It therefore follows from the dynamic solution (10a) that
the capital stock and output remain constant at all points of time. There are
no transitional dynamics. Instead, the economy moves instantaneously to
its new steady state, in which gC crowds out private consumption one-forone.22 In terms of Fig. la, the economy immediately jumps from P on XX to
A on XX and stays there. The unstable locus Y Y consequently
passes through point A rather than point Q. The fall in private wealth is
greater if employment is fixed, since the representative agent has no opportunity to offset through capital accumulation the impact of greater government
expenditure.
*The fixed employment

analogue to (11 b) is given by dj/dy,
dI/dg, > 0, we assume that if U,, i 0, then 1U,,J> 1UC,/.
= - (U,, - UCB).To guarantee
that
23Note that, because the stable and unstable loci for the fixed employment case possess the identical
slope characteristics
as their variable employment
counterparts,
Fig. la can be used to trace out the
dynamic effects of government
expenditure
under both fixed and variable employment;
see Appendix for details.
764
S.J. Tumovshy, W.H. Fisher/Journal
Fig. lb. Expansion
of government
expenditure
infrastructure
747-786
expenditure.
on infrastructure
The transitional response of k and I to a permanent increase in government

infrastructure expenditure is depicted in Fig. lb. We will describe the case in
which the net withdrawal effect is zero, F, = 1, and assume that public infrastructure is a complementary factor of production with capital and labor,
F,, > 0, Fl, > 0. As before, we assume that the economy begins at the equilibrium point P, although for a rise in gI, we rename the stable and unstable
adjustment loci described by Eqs. (lob) and (10~) as ZZ and W W, respectively.
(Also as before, the unstable locus for the initial equilibrium is not drawn.) In
contrast to the case of government consumption expenditure, a permanent
increase in government infrastructure expenditure will shift the new steady state
of the economy to the southeast of P, since (under present assumptions) this
fiscal shock causes a fall in the steady state marginal utility of wealth as well as
a rise in the steady-state capital stock. Another difference between the two types
of shocks is that while the initial response of 2 is unambiguously positive for
a permanent rise in gE, 2(O) can either rise or fall for a permanent rise in gr. This
S.J. Turnovs~,
W.H. FisherJJournal
of Economic Dynamics
and Conirol 19 (1995) 747-786
765
can be seen by evaluating (lob) at t = 0 which reveals that the initial behavior of
1 is governed by two off-setting factors. 24 These are its long-run decline to >r
and the effect of positive investment, which, because it initially leaves fewer
resources available for private consumption, tends to raise A(0). This latter
influence grows stronger the more rapid is the rate of stable adjustment,
represented by 1~~1,and the greater is the increase in k: Therefore, if the effect of
positive investment predominates, then the marginal utility rises and the economy moves immediately to point B on the new stable locus ZZ. (The shift in
the unstable locus to WW is also illustrated.) If, on the other hand, the
influence of the decline in I is stronger, then the marginal utility falls at t = 0 and
the economy will jump instantaneously to point B on the alternative stable
locus ZZ. (We do not, however, depict in Fig. lb the shift in the alternative
stable locus to W W .) The economy then either traverses to its long-run
equilibrium from B to R along ZZ or from B to R along ZZ. In both
instances, adjustment to long-run equilibrium involves capital accumulation,
k > 0, and declining marginal utility of wealth, 1 < 0. Capital accumulation
occurs because government infrastructure expenditure (i) directly raises the
marginal product of capital, Fkg > 0, and (ii) also raises the marginal product of
labor, F,, > 0, thereby initially increasing employment, which, in turn, acts as
a further stimulus to the marginal product of capital, Fkl > 0.25 With Fk
exceeding its long-run equilibrium value, p during the transition, the arbitrage
Eq. (2d) requires 1 < 0.
The
expression
for the initial response
di.(O)
~=_
dy,
(0, I - PI 1 dc
012
da ++--ii&.
Substituting
for Eqs. (13) evaluated
d1(0)
-=___--dyr
utility is given by
d:
- &Flg
pi
012
at F, =
1 and for H,, , 0, 2. this expression
reduces
to
dc
62 dg,
the sign of which is ambiguous

Using
of the marginal
given the restrictions
(5b), the initial jump in employment
we have imposed
on the mode).
equals
dl(O)=, d1(0)+,
dg,
Substituting
dI(0)
-=----9
dg,
dg,
for dl(O)/dg,
from Foonote
IF,,
~~1~ dr?
012
012 dg,
24 and for I, shows that the jump
in I(0) can be written
which is unambiguously
positive. Moreover, since dy(O)/dg, = F,dl(O)/dg, + 1, such an increase in
employment
implies that a permanent increase in g, has a multiplier effect on output initially as well
as in the steady state.
In contrast to a permanent increase in gC, for the special case of fixed

employment, a permanent increase in g1 still gives rise to transitional dynamics
for k and il. This follows directly from the steady-state marginal product
condition (7b), and the fact that with Fkg > 0, an increase in g1 will raise 6.
Because the capital stock is constrained to adjust continuously, the movement
to the new steady state entails a period of positive investment, k > 0. As in the
variable employment case, a permanent rise in gr under fixed employment leads
to a long-run fall in the marginal utility of wealth, since, as long as F, = 1, this
increases the capital stock and output sufficiently to cause a steady-state
increase in private consumption. 26 However, the initial jump in L(O),ambiguous
in the variable employment case, can now be shown to be positive, with the effect
of higher investment dominating that of the fall in 2, if employment is fixed.27
The reason this is so is because if employment is fixed, the representative agent is
forced to respond to the rise in g, solely by accumulating capital. This increases
the jump in L(O), since the rise in g1 at first crowds out private consumption.
Previously, the initial burden of government expenditure initial could be at least
partially offset through greater work effort, which raises output and thus
provides more resources for private consumption. In terms of Fig. lb, the
economy for the fixed employment case would move to point such as B at t = 0
and adjust down the stable locus ZZ toward the new steady-state equilibrium
represented by a point such as R.
5. Welfare effects of permanent fiscal policy
We turn now to the main issue, namely a comparison of the effects of
government consumption and infrastructure expenditure on economic welfare.
26For the fixed employment

d%
_=dg,
Fkk
- Fk,
dl
-_=u
da
Using these expressions

dj
_=dg,
d?
+ 1> 1
Substituting
Cc
-(l
-F,)+F,g
I.
-1
for the case Fg = 1, it is immediate

where
dg,
*The expression
dW3
-=
dg,
case, Eqs. (13) become
that
d=F,dk>O
dg,
dg,
for I(0) under fixed employment
is given by
d;i
dg,
for dl/dg,
from Footnote
e>
-d40) = u,,p,
de
dg,
0.
26 and assuming
F, = 1 enables
us to conclude
that
of Economic
Dynamics and Control 19 (1995)
747-786
161
In conducting this discussion, the criterion will be taken to be the welfare of the
representative agen and we will consider both the time path of this instantaneous utility level as well as the overall acumulated welfare over his infinite
planning horizon. We focus initially on the effects of permanent fiscal policies,
deferring analysis of temporary policies to Section 7.
The instantaneous level of utility of the representative agent at time r, Z(t), is
specified to be
(14)
Z(r) = U@(r), &),sc),
with the overall level of utility over the agents infinite planning horizon, being
the discounted value of (14), namely:
a
W =
U(c,I,g,)e-Bdt
I
do
Z(t)e-Bdt.
(15)
s0
We will analyze the effects of government consumption and infrastructure on

both Z(t) and W when c and 1 satisfy the equilibrium paths described by
(5aH5b), and k and 1 evolve in accordance with (6a)-(6b).
We begin by differentiating Z(r) with respect to gC,
- = -+u*+u.
d-W)
ds,
Wt)
dg,
(16)
Using the optimality condition for work effort, Eq. (2b), (16) becomes
dgc
1 9
Fdlo
+u
(17)
Next, differentiating the product market equilibrium condition (4), with respect
to gE, yields
d&) + 1
F dk(t) + F dl(t) = -de(r) + ~
k dg,
dgc
da
dsc
(18)
enabling us to rewrite (18) as
dZ(t)
dg,
= u,(C, 1,Sc)-
uc(C,I, gc)+
dk(t)
u,
Fk~
dg,
dR(t)
- ~
ds,
1
.
(19)
Following the same procedure, we obtain the analogous expression for the effect
of government infrastructure expenditure on Z(t),
dZ(t)
= U,[F,(k,Lg,)
dg,
- 11 + u,
dk(t)
Fkp
dg,
dk(t)
- ~
&,
(20)
168 S.J. Turnov&,
W.H. Fisher/Journal of Economic Dynamics and Control I9 (1995) 747-786
Using Eq. (lOa), describing the (linearized) equilibrium adjustment path

followed by the capital stock, (19) and (20) can be linearly approximated by
the expressions:28
d-W
-=
dgc
U, - U, + U,[Fk(l
dz(t)
-=
dg,
U,(F, - 1) + U, [F,(l
- ePlf) + piel]-$,
(19)
- el) + pi ePl] fi
dg,
Examination of (19), (20) or (19) (20) reveals that the effect of an increase in
either form of government expenditure on the level of instantaneous welfare
consists of two distinct components. The first consists of what we shall call the
direct crowding-out efict. This reflects the fact that as the government increases
its expenditures, it takes away resources from the private sector, thereby reducing private consumption one-for-one. In the case of government consumption
expenditure, this is measured by the difference between the marginal utility of
public consumption and that of the foregone private consumption, U, - U,. In
the case of government expenditure on infrastructure, it is the difference between
the utility value of the marginal product of infrastructure expenditure and the
marginal utility of the private consumption foregone, U,(F,- 1).29
The second component of the effect of gE and gr on Z(t) consists of intertemporal influences which operate through the response of the capital stock, and
which we shall term the intertemporal capital accumulation e&t. From (19) and
(20) this effect is seen to depend upon how the government expenditure influences
the rate of capital accumulation, and how in turn the resulting change in the
accumulated capital stock impacts on output, and therefore on private consumption. It is important to observe that these two influences have conflicting effects on
the agents instantaneous level of welfare. This is because, by taking away
resources from current consumption, a given level of investment lowers instantaneous welfare, while accumulated capital raises output, thereby increasing
consumption and welfare over time. The intertemporal tradeoff can be demonstrated most easily by evaluating (19) (20) for the initial, Z(O), and the steady
state, 2, impacts of government expenditure. For gC,the resulting expressions are
WO)
-=
dg,
*These
u, -
expression
UC+ UcPt
$E
are only approximations
dZ
-=u,-u,+u,:F~$
dsc
in that all derivatives
are evaluated
at steady
(21)
state.
Because
(19) and (20) are approximations,
(U, - U,) and UJF, - I) are constant terms, evaluated at the steady state. This is in contrast to the corresponding
terms in the exact expressions (19)
and (20). which vary as the economy adjusts toward its steady state.
while the corresponding
169
expressions for g1 are

dp
- = U,(F, - 1) + UC&d%
dg,
dg,
(22)
Leaving aside the crowding-out terms, which scale the adjustment paths of
welfare, Eqs. (21), (22) show that to the extent that government expenditure
induces an instantaneous
rise in investment, d/$O)/dg, = - pldl/dg,,
d,&(O)/dg,= - pldc/dg,, and consequently a reduction in private consumption, its short-run effect is welfare deteriorating. Such a deterioration in
welfare is, however, eventually reversed as the accumulation of capital over
time raises output, which makes possible greater private consumption and this
is welfare-improving in the long run. Indeed, provided government expenditure
raises the long-run capital stock, the time derivatives of (19) and (20) show
that these fiscal policies lead to continuous improvements in welfare as the
economy moves toward its steady state.
While the welfare effects of the two forms of government expenditure are of
analogous form, they generally differ in magnitude and in their time profile. To
consider this, we subtract (19) from (20):
dZ(t)
dZ(t)
---=U,F,-U~+U,CF,(I-eY.)+r,eY1,(~-~).(23)
dg,
dg,
Using (23), we see that the form of expenditure providing the greater direct
benefits depends upon the sign of U,F, - U,. Further, as long as
dE/dg, # d@dg,, as is generally the case, government consumption and infrastructure expenditures generate distinct time paths for Z(t), i.e., distinct
intertemporal welfare tradeoffs. For example, if as suggested in Section 3,
a permanent expansion in public infrastructure expenditure has a greater
effect on the long-run capital stock than does a permanent expansion in public
consumption expenditure, then g, generates a higher level of transitional
investment than does gC. This implies that expenditure on infrastructure
requires the agent to sacrifice more welfare initially in exchange for
consumption
increased steady state welfare, relative to government
expenditure.
A linear approximation to the overall level of welfare, represented by Eq. (15),
can be obtained by observing that along the equilibrium path Z(t) can be
approximated by
Z(t) =
2 + (Z(0) -
Z)ePlr.
(24)
710 S.J. Turnovsky,
W.H. Fisher/Journal
of Economic Dynamics and Control I9 (1995) 747-786
Substitution of (24) into (15), and integrating, yields
z +(Z(O)- a
B
(25)
B-h
The first term of (25) is the capitalized value of instantaneous welfare, Z(t),
evaluated at the steady state. It is the level of welfare which would result if the
steady state were attained instantaneously. The remaining term reflects the
adjustments to this, due to the fact that the.steady state is reached only gradually
along the transitional path.
Differentiating (25) successively with respect to gCand g, and using Eq. (21)
and (22), we derive the following expressions:
Noting further that in the neighborhood

reduce to
dW
-=
dg,
(U, - U,)
B
dW
-=
dgr
U,(F, - 1)
of equilibrium
Fk = 8, Eqs. (26)
(274
VW
Thus the net effects of permanent increases in gE and g, on total welfare are
simply the respective crowding-out effects. Since these last indefinitely, they are
just equal to the instantaneous effects, capitalized at /I. Most importantly, the
influence of the path of Z(t) on total welfare nets out to zero, with the capitalized
ga$s to W st_mming from the steady-state increases in the capital stock, (U,
dk/dg,), (U, dk/dg,), precisely offsetting the discounted losses from the consumption foregone along the transitional path.
It is important to stress that the essentially static relationships (27) represent
the welfare effects both along the dynamic transitional path and in the new
steady state. Indeed, the total negative effect of a permanent increase in government expenditure on private activity, - UC/B, can be decomposed, e.g., for gE,
into - U, dl/dg, and - U,(( 1 - /?dk/dg,)/fl), which represent respectively these
two phases.
S.J. Turnovsky. W.H. Fisher/Journal
747-786
711
Setting Eqs. (27) equal to zero enables us to find the conditions for which yC
and g, are at their welfare-maximizing levels. These are, respectively,
u, = UC,
(28a)
F,=
(28b)
1.
In other words, the marginal utility of public consumption should be equated to

the marginal utility of private consumption, while the marginal physical product
of public infrastructure should be set at unity (its resource cost). The optimality
condition (28a) is precisely the same as that obtained previously in models which
abstract from capital accumulation; see, e.g., Turnovsky and Brock (1980). But
there is a crucial difference. The Turnovsky-Brock
analysis abstracts from
capital accumulation so that there is no transitional dynamics; the economy is
always in steady-state equilibrium. By contrast, in the present analysis, the
dynamics are gradual, and although optimal levels of government expenditure
are determined by similar static conditions, they nevertheless incorporate the
welfare along the transitional path.
Z
_-_______________________________
Fig. 2a. Time path for instantaneous
utility -~ Permanent
expenditure
increase:
U, = U,, F, = 1.
172
S.J. Turnovsky, W.H. FisherJJournal
We summarize the analysis of this section in Fig. 2a, which depicts the paths
taken by Z(r) for permanent increases in gE and gr. The locus CC depicts the
path of Z(t) generated by an increase in gf, while II depicts that generated by an
increase in gr. We illustrate the case in which dk/dg, > dc/dgc and assume that
gEand gr are set optimality. This assumption, by setting the crowding-out effect
to zero for each policy, provides a common reference point for the paths of Z(t).
Note that the relative positions and slopes of the II and CC curves reflect the
fact that gI generates more transitional investment than gE, and therefore
a greater intertemporal tradeoff.30
6. The dynamics of temporary fiscal shocks

This section briefly discusses the dynamic adjustments to temporary increases
in the two forms of government expenditure. Specifically, we assume that at time
0, say, the government increases its expenditure, which it maintains at the higher
level until time T > 0, say, when it is (correctly) expected to be restored to its
original level. The formal solutions underlying this analysis are presented in the
Appendix. These solutions are, however, derived under the assumption of fixed
employment. This restriction has been imposed the following reasons. First, it is
difficult to obtain tractable expressions for the solutions of k and I for temporary
increases in gc and gr, largely due to the generality of the steady-state responses,
Eqs. (11) and (13), derived under endogenous employment. More importantly,
this assumption allows us to sharpen the distinctions between the effects of gf
and gI. This is due to the fact that with fixed labor supply, the agent cannot
respond to the negative wealth effect common to both policies with greater work
effort, which, whether brought about by higher gc or gr, tends to raise capital
accumulation and output and lead to similar transitional adjustments.
6. I. Temporary increase in government
consumption
expenditure
This is illustrated in Fig. la. When the temporary increase in gEcommences,

the stable and unstable loci shift to XX and YY respectively. This system
passes through point A, which denotes the steady state the economy would
attain, and would attain instantaneously, under fixed employment, if the rise in
soThe difference between the time paths for Z(t) to permanent

increases in gC and g, becomes
extreme if employment
is fixed. In this case, the impact on Z(t) of a permanent
increase in gC
collapses to the crowding-out
effect. There is no transitional
adjustment,
since, as discussed above,
such a fiscal expansion
generates no capital accumulation.
By contrast, the response of Z(t) to
a permanent increase in g, with fixed employment
retains the essential qualitative characteristics
of
the path II illustrated in Fig. 2a.
S.J. Turnovsb,
W.H. Fisher/Journal
713
gC were permanent. The stable and unstable loci remain in this position for
duration of this fiscal expansion, at the end of which they revert to their original
locations, XX and Y Y, intersecting once again at point P.
As in the case of a permanent increase in gC, the adjustment begins with
a positive jump in the marginal utility of wealth. However, because the economy
discounts the effects of a temporary increase in gCthe rise in L(O)falls short of its
response in the permanent case. This leaves the economy at some point, such as
L, between P and A in Fig. la. The height of the jump in i(O) increases with the
duration T of the temporary disturbance, reflecting the fact that the more
prolonged is the increase in gEthe more closely its initial impact on the economy
corresponds to that of a permanent increase. During the period that gEis at its
higher level, the economy traverses the unstable path LM, reaches the original
stable locus XX at point M, and from there, after gChas been restored to its
initial level, moves down XX to its steady-state equilibrium at point P.
For a temporary increase in gCthe economy, in contrast to its response in the
permanent case (with fixed employment), does not immediately reach its steady
state and thus its adjustment is characterized by transitional dynamics. It is the
difference in the behavior of n(O) for the two cases which is the source of this
distinction. Since the increase in L(O)in the temporary case is less than its increase
in the permanent, the initial fall in private consumption is likewise less than its fall
in the permanent case. Recalling that a permanent rise in gCimmediately crowds
out an equal amount of private consumption, the fact that the initial decline in
private consumption falls short of this in the temporary case implies that, with the
capital stock and consequently output given at t = 0, the initial response of the
economy is disinvestment, k(O) < 0. In other words, the agent, discounting the
negative wealth effect of a temporary increase in gC,but also lacking the opportunity to counteract it with greater work effort, enjoys a greater level of private
consumption by decumulating capital. As long as gC is at its higher level, the
capital stock continues to decline. This raises its marginal physical product above
its long-run value /I and requires, consistent with the optimality condition (2~)
that x < 0 during this period. The return of gEto its original level reverses the prior
decumulation of capital. Investment is immediately crowded in at t = T and is
followed by a rise in the capital stock. We illustrate this by the movement of the
economy down the stable locus XX. Until k = k0 at P, the marginal physical
product of capital remains above fi and hence ,? < 0 for I > T.
6.2. Temporary increase in government
expenditure
on infrastructure
We consider next the response of the economy, illustrated in Fig. lb, to an

unanticipated temporary increase in government infrastructure expenditure, gl.
Under fixed employment, the loci describing stable and unstable state variable
dynamics shift immediately to ZZ and W W , respectively, and pass through
point R, the long-run equilibrium, if the increase in gI were to be permanent. As
714 S.J. Tumovsky, W.H. Fisher/Journal
for a temporary increase in gC,the stable and unstable loci stay in this position
for the duration T of the fiscal expansion, before shifting back to ZZ, W W.
The state variables follow an unstable path such as EF during the period that gI
is at its temporarily higher level, reach the original stable locus Z at t = T,
and converge thereafter toward their steady-state position at P.
We observe that the initial response of k and 1 to a temporary rise in gr is
qualitatively similar to that which takes place subsequent to a permanent increase. That is, the behavior is characterized by a positive jump in the marginal
utility and investment, followed by capital accumulation and declines in the
marginal utility. As for a temporary rise in gC,the jump in L(O) is an increasing
function of the duration of the fiscal expansion. The transitional adjustment of
k and 1 is brought about because a temporary rise in g,, like its permanent
counterpart, initially lowers private wealth and directly raises the marginal
physical product of capital above fi. But since the economy is characterized by
forward-looking dynamics, capital accumulation ceases at some time before the
return of gr to its original level. Thereafter, the capital stock declines toward its
steady-state value, first along the unstable path and then along the stable axis ZZ.
The marginal utility rises during the final phase of adjustment, reflecting the fact
that the return of gr to its original value lowers, because Fkg > 0, the marginal
physical product of capital below the rate of time preference. As pictured in
Fig. lb, the decline in the marginal utility to point F at time T is less than the
steady-state fall that takes place if the increase in g, is permanent. We can show,
however, that the fall in l(T) exceeds the fall in 1, if T is sufficiently large.31
7. Welfare effects of temporary fiscal expansions

As before, the agents welfare is evaluated both along the transitional path
and over the agents infinite planning horizon, although the derivations of Z(t)
and W for temporary fiscal policies are relegated to the Appendix. In Fig. 2b, the
path RS-UV depicts the response of Z(t) to a temporary rise in gE while HZJ
I Using (A.9b) and Footnote

dX
---
dl(T)
26, we infer this by evaluating
the expression:
-U,
at T = 0 and T = co. This intuition behind this result lies in the fact that the greater is the duration
of the temporary expansion in g,, the greater is the accumulation
of capital during the initial period
of adjustment.
Equally, however, a relatively large initial rise in the capital stock requires that just
prior to time T there be a relatively rapid rate of disinvestment
in order for the economy to reach the
stable locus XX at t = T. Such disinvestment
increases, because Fxx < 0, the marginal physical
product of capital relative the time rate of preference and, consequently,
causes i.(T) to fall below >,
for sufficiently large T.
SJ. Turnovs~,
W.H. Fisher/Journal
175
Fig. 2b. Time path for instantaneous

increase: Ii, = U,, F, = 1.
utility
(for fixed employment)
- Temporary
expenditure
traces out that for a temporary increase in gl, both path being drawn under the
assumption of fixed employment. To facilitate comparisons, the innocuous
assumption is made that each policy is of common duration T. In describing the
evolution of Z(t), we also assume, as we did previously in deriving Fig. 2a, that
the fiscal policy authorities set gC and g1 at their welfare-maximizing levels.
Notably, the same welfare-maximizing conditions apply for both temporary and
permanent fiscal expansions, due to the fact, shown in the Appendix, that the
effect on overall welfare of temporary increases in gC and g, are simply the
crowding-out effects discounted over a finite, rather than an infinite, horizon.
As is evident from Fig. 2b, temporary increases in gCand gr have opposing
initial effects on Z(t). That is, Z(0) rises to a point such as R for a temporary rise
in gC and falls to a point such as H for a temporary rise in g,. This result is
a direct implication of the distinct impact the two policies have on capital
accumulation. Temporary increases in gC lead to disinvestment, which, as described above, prevents private consumption from being crowded out one-for-
one with the increase in gC.This means, with gCset optimally, that the welfare
losses associated with lower private consumption are exceeded by the welfare
gains associated with greater gC and, consequently, that Z(0) takes a positive
jump. By contrast, temporary increases in gr cause capital to accumulate,
which, again as outlined above, constitutes initially a shift away from private
consumption. Such a fall in private consumption, coupled with the fact that the
increase in gr does not itself yield direct welfare gains, necessarily causes a
fall in Z(0).
Further welfare gains, illustrated by the movement of Z(t) along the locus RS,
accrue to the agent while gC remains temporarily at its higher level. Welfare
continues to improve, due to the fact that the decumulation of capital that occurs
during this period permits the agent to enjoy greater private consumption. There
are welfare gains as well after t = 0 via greater private consumption for the case of
a temporary rise in g,. Unlike those for the case of greater gC,however, these gains,
represented by the movement of Z(t) up HZ, are generated by the growth in the
capital stock and output that occurs during the initial phase of adjustment. In fact,
the increase in the capital stock and output subsequent to the rise in gI is sufficient
to bring private consumption, and hence welfare, above their initial values at some
time prior to T. Further, we can show, although this not pictured in Fig. 2b, that for
the case discussed above in which A(T) < 1,, i.e., the case of a prolonged temporary
increase in gI, both private consumption and welfare at time T overshoot the
steady-state values they attain subsequent to a permanent increase in g,.32
The behavior of welfare at, and after, time T, when expenditure is restored to
its original level, differs significantly between the two types of expenditure. In the
case of consumption expenditure, gE,at time T, Z(T) takes a discrete jump from
a point such as S above its initial value, to a point such as U below its initial
value. This is because government consumption expenditure generates direct
welfare benefits for the household, so that its contraction at time T causes a fall
in welfare, which takes Z(T) below its initial level, due to the fact that private
consumption at the close of the fiscal expansion is less than its initial value.33
3zThis result follows from Footnote
c(T), Z(T)
overshoot
31 and the relationship
C, 2 as i.(T) overshoots
between
R, c, and Z. That is, since
1.
Private
consumption
itself takes a discrete jump at time T, since it too depends directly on the
level of y<. However, we can show that the jump in private consumption,
unlike that for instantaneous welfare, is ambiguous
and equal to U,,/U,.
Thus the jump in private consumption
is
positive if U, i 0 and negative if U,, > 0 (see also Djajic, 1987, for this result). Even if the jump in
private consumption
is positive, c(T) is nevertheless less than its value prior to the increase in &.
This guarantees
that the jump in Z(T) is negative.
S.J. Turnovshy, W.H. Fisher/Journal
of Economic Dynamics and Control I9 (1995)
747-786
717
After gC returns to its original level, the agent receives the welfare benefits
that accrue from the subsequent rise in the capital stock and output. We depict
this by the movement of Z(t) along UV, the path which takes welfare back to its
steady-state level. In contrast to gE, government infrastructure expenditure
yields no direct welfare gains for the agent. As a consequence, the return of gr to
its original value does not lead to a discrete downward jump in Z(T). Instead,
the fall in g, reverses the previous growth in the capital stock and output, and
thus leads to a continuous decline in private consumption and welfare, the latter
illustrated by the adjustment of Z(r) down the path IJ. In sum, temporary
increases in gr give rise to much smoother welfare adjustment paths than those
brought about by temporary increases in gC.
8. Conclusions
How a government chooses to allocate its expenditures is an important, but

little-analyzed public policy issue. In this paper we have used the intertemporal-optimizing market-clearing framework to compare the effects of government consumption expenditure, on the one hand, and government expenditure
on infrastructure, on the other, on macroeconomic performance. While our
analysis has touched on quite far-reaching aspects of this issue, we shall summarize by highlighting a few of the main findings.
We have shown how the effects of either form of government expenditure on
the long-run stock of capital can be broken down into two components. First,
there is what we have called the resource withdrawal effect. This reflects the fact
that, to the extent that the government activity involves a reduction of resources
available to the private sector, it imposes a negative wealth effect. This generates
an intertemporal substitution in work effort, encouraging the accumulation of
capital, and leading to an overall expansion of economic activity. This effect is
clearly larger for government consumption expenditure, than it is for expenditure on infrastructure. This is because, while the former is nonproductive, the
latter contributes directly to the productive capacity of the economy, and to the
extent that it does so, it is resource-augmenting rather than withdrawing. In the
extreme case that the marginal physical product of infrastructure exceeds its
resource cost (equal to unity), this net effect would be contractionary.
The second component of either form of government expenditure depends
upon how it impacts on private decisions. In the case of government consumption expenditure it is its impact on the marginal rate of substitution between
private consumption and work effort. This may either enhance or offset the
resource withdrawal effect. In the case that the utility function is either additively or multiplicatively separable in private and public decisions, this second term
is zero and only the resource withdrawal effect operates. By contrast, the
secondary effect of government expenditure on infrastructure stems from its
118 S.J. Tumovsky
W.H. Fisher/Journal
of Economic Dynamics and Control 19 (199.5) 747-786
impact on the marginal physical products of the private factors of production,

capital, and labor. In general, these effects on private factor productivity are
likely to offset (at least in part) the first component.
Taking these two sets of effects into account, whether a unit increase in
government expenditure on infrastructure has a larger impact on the capital
stock than does a corresponding increase in government consumption expenditure, is not entirely clear. Plausible conditions are suggested under which
expenditure on infrastructure will be the more productive in this respect, but the
reverse certainly cannot be ruled out.
Our second main concern has been to focus on the effects of the two forms of
government expenditure on economic welfare. Both the time path of instantaneous utility and the overall welfare level have been considered. We have
shown how the effects of a permanent increase in either form of government
expenditure consists of two factors. The first is the direct crowding-out effect,
which reflects the utility differential between the government expenditure being
undertaken, and that of the private consumption it is displacing. The second
describes the intertemporal tradeoff between the short-run rate of capital accumulation and the resulting change in the capital stock. These latter two effects
are in conflict from a welfare point of view and give rise to intertemporal
tradeoffs in utility. While the long-run accumulation of capital leads to welfare
gains through the growth in output and additional consumption it generates, in
the short run, the consumption foregone, while capital is being accumulated
leads to short-run reductions in utility. Consequently, a permanent increase in
government expenditure gives rise to a rising level of instantaneous utility over
time. To the extent that the two types of government expenditure lead to
different adjustment paths in the capital stock, they leave the agent with different
resource constraints through time, and thus are associated with distinct intertemporal welfare tradeoffs. The form of government expenditure having the
larger long-run effect on the capital stock (probably infrastructure) will be
associated with a greater short-run welfare loss, accompanied by a more rapid
improvement over time. The contrasts in the intertemporal welfare tradeoffs are
quite dramatic in the case of only temporary increases in government expenditure.
The net effect of permanent increases in either form of government expenditure on the overall welfare of the representative individual turns out to be
surprisingly simple. It is just equal to the capitalized crowding-out effect. The
capitalized steady-state gains in welfare resulting from the permanently higher
capital stock are precisely offset by the losses resulting from the additional
consumption foregone along the transitional path. The optimal intertemporal
level of government consumption expenditure is then simply to equate the direct
marginal utility of government consumption expenditure to the marginal utility
of private consumption. Analogously, the corresponding optimality condition
for government infrastructure is to set its marginal product to its resource cost
779
(unity). This result, in conjunction with recent empirical estimates obtained by

Aschauer (1989) and others, suggest that infrastructure in the United States is
seriously undersupplied. Finally, we should emphasize, that while these optimality conditions are static, they do reflect welfare along the entire intertemporal
adjustment path (at least to a linear approximation). But at the same time, their
restrictive nature should be recognized. They relate to optimal fixed levels of
expenditure. A more general approach to optimal fiscal policy would determine
the entire optimal time paths for government expenditures, as the economy
evolves over time.
Appendix
A. 1. Properties of short-run solutions
Taking the differential of Eqs. (5a)-(5b) yields the following partial derivatives
with respect to ,I, k, gC, and gr:
(A.lb)
ac
UdF,,
ag,-
(A.ld)
where D = U,,(UII + lFll) - UB > 0.
A.2. Steady-state responses of employment, consumption, and output

To obtain the steady-state effects of permanent increases in government
consumption and infrastructure expenditure on employment, consumption, and
output, differentiate Eqs. (5) and y = F(k, I,g,) with respect to gE and gI, and
combine with the corresponding steady-state responses of k and 2, given in
Eqs. (11) and (13) respectively. The following expressions result:
180 S.J. Turnovsky,
Government
di
W.H. Fisher/Journal
consumption
Fkl
dC?
- Fkk
_-
expenditure
Fkk dk
dg,=--
dg,-
DA
&l,
(UU + U,IFJ
- (YIr)KF:
04.2)
where A = 811022 - t9,202, > 0.

Government
infrastructure
expenditure
_=dg,
di
dc
Fkkh(l - Fg) +
A
Fkkvh
bfx1
F,)
Fkg_p
wll
&/8FkkFlg
DA
A
- ~(~/bFknFlg
DA
@/~Fkgi
(A.3b)
+ F
(A.3a)
DA
w/im.d1 - Fg) wll + wwk
dgx
DA
wwk
DA
dg,=-
di
_=-
F,,
-1 %k
-y+z
%/i)Fkli Fkg
DA
(A.3c)
Evaluating these expressions, assuming a zero net withdrawal effect, F, = 1, and

also Fkg > 0, F1, > 0, reveals that
dc
->o,
dgr
dY
->l.
dg,
Even under these conditions, however, the long-run effect of gI on iis ambiguous.
S.J. Turnovsky. W. H. Fisher/Journal
of Economic Dynamics and Control I9 (I 995) 747-786
78
A.3. Solutions for the capital stock and the marginal utility of wealth for temporary
jiscal shocks
As noted in the text, temporary shocks are analyzed under the simplifying
assumption of fixed employment. In this case, the linearized dynamic system
simplifies to
li
0(
1
Fk
- XFkk
(A.4)
We assume that the system starts at t = 0, in steady state with i = k,,, I= &.
For temporary fiscal expansions, the solutions for k and I are over two phases:
(i) the initial phase of higher government consumption and infrastructure
expenditure and (ii) and the subsequent phase in which both types of government expenditure have returned to their original levels. The shift in the steady
state occurs at time T. The steady states corresponding to these two phases are
(R,,I, ) and (k,, I,,),,,respectively.
The general solution to (A.4) is
(ASa)
(ASb)
k = k0 + A;el + A;ez,
(A.6a)
2 = 1, + Ucc~2A;e* + U,,pl A;ej2,
(A.6b)
where pi < 0 and p2 > 0 are eigenvalues. There are four arbitrary constants,
Al, AZ, A;, A; to be determined. These are evaluated as follows:
(9 In order for the transversality condition (2e) to be met, we require: A; = 0.

(ii) We assume that the capital stock adjusts continuously from its inital given
stock k,,, implying k0 = l, + AI + AZ.
(iii) The time paths for k and 2 are assumed to be continuous for r > 0. In
particular, at time t = T, the solutions for (A.5) and (A.6) must coincide,
yielding two more equations for A 1, A2, and A;, which together with (i) and
(ii) uniquely determine the solution.
We now use this method to determine the solutions for k and 1 for temporary
increases in gE and g,.
Temporary increase in gC
As discussed in Section 3, k, = k0 for a temporary

solutions are as follows:
increase in gC. The
OltlT:
Celc2_ ePl](xl _ I,)
,-AT
k=kO+
UCC(P2-
I=;il+e
-PzT[~~~PZ
(A.7a)
Pl)
p2ep~](;il -
I,)
(A.7b)
(Pz-Pl)
t 2 T:
(A.8a)
(A.8b)
Temporary increase in gI
To determine the following solutions for k and 1 for a temporary rise

in gI, we use the_ fact that, under fixed employment,
(1, - I,) =
- u,,t-(1 - F,) - F&l - kdl.
kl
[(p2 - pl) + pie -PzT]e~l(~l - k,) + pLee2c-(ff, - k,)
(P2
e-
/hT
PI _
ePZ](l
Ce
Pl)
(P2
_
1
ucc~2C(p2
- PI) + he ~p2Tlep1(~l - k,) + UCCpfev2( (RI - k,)
(CL2 -
P2)
(A.9a)
(PLZ-Pl)
F,)
Pl)
Ucfe-p'TCp2e @I- ,klePz](l - F,)

b2
PI)
(P2
Pl)
(A.9b)
S.J. Turnowky, W.H. Fisher/Journal of Economic Dynamics and Control 19 (1995) 747-786 183
t 2 T:
k = k,, + [ - (pz - pI)[l
- e --pLT] + PI [e -PI - e -WzT]]
ePlf(& - k,)
(P2
Ce-
PIT _
-PzT]ePtt(l
(A.lOa)
(P2
CL11
ePl(& - k,)
;I=;io+Ufc~2[-(~2-~(1)[1-e-17]+~~[e~~1T-ee-zT]]
(P2
_
Pl)
_ F,)
Uccp2[e-pIT
e-P~T]eP~(l - FS)
(P2
Pl)
(A.lOb)
PII
A.4. Solutions for welfare for temporary jiscal shocks

For the fixed employment case, instantaneous
welfare 2 is given by
(A.1 1)
Z = u(c@?gC),gE).
To obtain expressions for Z for temporary increases in government consumption and infrastructure expenditure, we take a first-order approximation of
(A.1 1):
z=wozgc))+
U,(A u
I)
,
(A.12)
cc
and substitute from Section A.3 the solutions (1 - 2) for the appropriate fiscal
policy and phase. The value of V(c(I,g,),g,) is determined by the level of gC
and gI.
Temporary increase in g,
Using Eqs. (A.7b) and (A8.b), we determine the following solutions for Z for
a temporary increase in gE:
OjtlT:
(A.13)
t 2 T:
(A.14)
784 S.J. Turnovsky.
W.H. Fisher/Journal
where & denotes the temporarily

expenditure.
greater level of government
consumption
Temporary increase in g,
Using Eqs. (A.9b) and (A.lOb), the solutions for 2 for a temporary increase in
gI are given by:
Ucpfep2('-T)(~l
k,)
+
(CL2 -PI)
+
Ucepp2T[p2e
pI' -
~rez](l - FS)
(A.15)
9
(cl2 -A)
t 2 T:
~M$,&),c%)
_ U,p2[e
U,p2[
-(p2
-pl)C1
-e-"'T]
--pIT- ePzT]ePlf(l - FB)

(P2 -k)
(A.16)
'
where S, denotes a fixed level of government consumption expenditure.

To evaluate the impact of temporary fiscal policies on overall welfare W, we
take the discounted value of the two phases of Z over an infinite horizon:
23
w=
Z(t)ee8dt
Z(t)eeBdt.
(A.17)
Substituting (A.13) and (A.14) into (A.17) yields the overall welfare generated by
a temporary increase in gE:
w =
U(,-(X,,&),s^,)C1
- eeBTl + W($dde-BT
B
(A.18)
S.J. Turnovsky,
W.H. Fisher/Journal
785
Similarly, substitution of (A.15) and (A.16) into (A.17) solves for the impact of
a temporary increase in g, on W:
(A.19)
Differentiating (A.18) and (A.19) with respect to gCand gr respectively yields
dW
dy,=
- (U 9 - U )[l - emBT]
dW
;
3dg,=
- U,(l - F,)[l
P
- ePST]
(A.20)
from which we see that the conditions for welfare maximization are identical for
temporary as for permanent fiscal policies.
Aaron, H.J., 1990, Discussion on Aschauer, Why is infrastructure

important?,
in: A.H. Munnell, ed.,
Is there a shortfall in public capital investment? (Federal Reserve Bank of Boston, MA) 21-68.
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model of saving and investment, Econometrica
51, 6755692.
Aschauer, D.A., 1988, The equilibrium
approach
to fiscal policy, Journal of Money, Credit, and
Banking 20, 41-62.
Aschauer,
D.A., 1989, Is public expenditure
productive?,
Journal
of Monetary
Economics
23.
17 7-200.
Aschauer, D.A., 1990, Why is infrastructure
important?,
in: A.H. Munnell, ed., Is there a shortfall in
public capital investment (Federal Reserve Bank of Boston, MA) 21-68.
Aschauer, D.A. and J. Greenwood,
1985, Macroeconomiceffects
of fiscal policy, CarnegieeRochester
Conference Series on Public Policy 23, 91-138.
Bailey, M.J., 1971, National income and the price level, 2nd ed. (McGraw-Hill,
New York, NY).
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effects of government
purchases,
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of Political Economy
89,
1086-l 121.
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to fiscal policy, in: R.J. Barro, ed.. Modern business
cycle theory (Harvard University Press, Cambridge,
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spending in a simple model of endogenous
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Political Economy 98, S1033S125.
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JOURNAL OF

of Economic Dynamics and Control

The composition of government expenditure and its

aDepartment of Economics, University of Washington, Seattle, WA 98195, USA

May 1993; final version

The effects of government expenditure on aggregate economic activity is

748 S.J. Turnovsky,

of Economic Dynamics and Control 19 (1995) 747-786

as specific economic problems have become more prominent. A central concern

See Blinder and Solow (1973) and Turnovsky

finds that government

model is a good example

of Economic Dynamics and Control 19 (1995)

who criticize Aschauer largely on the grounds of econometric method.5 By contrast,

of trend. They further

roads are highly productive,

focus on the productivity

derived from an intertemporal

generalized method of moments estimation procedure.

equals 0.16, but she notes that

techniques for estimating

that his results are biased due to the

that corrects for the endogeneity

0.10 to 0.30. Finn augments

and employs the

Her point estimate for the elasticity

models with nonstationary

variables, find an average output elasticity of

150 S.J. Turnovsky

of Economic Dynamics and Control 19 (1995) 747-786

on household wealth, most of these authors allow government expenditure to

For example, originating

of Economic Dynamics and Control 19 (1995) 747-786

91n our analysis of the temporary

fixed. This is less

152 S.J. Turnovs~,

of Economic Dynamics and Control 19 (1995) 747-786

consumption, c, labor supply, 1, capital stock,

and holdings of government

subject to the budget constraint

and initial conditions

where gC= real government consumption expenditure, g1 = real government

We adopt the following notation. Partial derivatives are indicated by corresponding

~MFU = F$, FuJ,

S.J. Turnovsky, W.H. Fisher/Journal

of Economic Dynamics and Control 19 (1995)

ISThe same assumption

is made by Barro (1990) in his analysis

S.J. Turnovsky, W.H. Fisher/Journal

of Economic Dynamics and Control 19 (1995)

U,(GLSC)= - Fdk, 1,s,)k

lF,(k, l,g,) = - j + l/I,

of Economic Dynamics and Control 19 (1995) 747-786

11> 0, lk > 0, 1, > 0, I,, > 0.

The dynamics of the economy are obtained by substituting the short-run

F(kW,k,g,,g,),g,) - cG,k,g,,g~) - gc - gr,

Eqs. (6) comprise an autonomous dynamic system which jointly determines

756 S.J. Turnovsky, W.H. Fisher/Journal

of EconomicDynamics and Control 19 (1995) 747-786

The steady state of the economy, reached when k = 1 = 0, is obtained from

16The signs of II,,

The sign of 0 *I is determined

S.J. Turnovsky, W.H. Fisher/Journal

of Economic Dynamics and Control 19 (1995) 747-786