Crowding out or crowding in? Reevaluating the effect of government spending on private economic activities

Abstract

The effect of government spending on private economic activities is an important topic that has been studied mainly in the time dimension, with relatively little research covering how government spending affects the private sector in the time-frequency space. With a continuous wavelet approach, this investigation contributes to the extant literature by characterizing the impact of government spending on private economic activities across frequencies and over time using a quarterly dataset from the Republic of Korea. The empirical results demonstrate that: First, private consumption changes could be largely captured by government spending fluctuations at high frequencies before 1970 but at only low frequencies between 1990 and 2010. Second, government spending crowds in private investment at the scale of 2–8 years between 1970 and 1985, but it crowds out private investment at the 8-16-year scale during the same period. Third, government spending increase leads to employment decrease at the 4-16-year scale between 1980 and 1990, but expansionary public spending results in employment increase at 2-4-year scale between 2000 and 2010. Our findings imply that policymakers should consider the heterogeneous effect of government spending on private economic activities when setting policies designed to rejuvenate the economy.