Real government size, automatic feedback rules and the measured effectiveness of fiscal policy

Abstract

This paper argues that as intervention, fiscal policy means more than simply any change in government spending and this requires of fiscal analysis a measure that separates the allocative from the counter-cyclical activities of government. Defining intervention as an optimal policy rule that responds automatically to privately unanticipated variations in output, a general equilibrium model is built to separate the supply side effects of desired changes in the size of government from demand side interventions designed to stimulate aggregate demand. The model is tested using the results of a public choice investigation of the real size of government (Ferris and West, 1996). That exercise produces a measure of desired size and, through its residual, an implicit measure of intervention. The paper tests the prediction that increases in desired size increase aggregate supply and that ex post measures of fiscal intervention can be recovered and tested for their effect on aggregate output. The test uses CITIBASE US annual data from 1959 through 1989.