Chapter 5 Government demand
In all market economies, the government plays an important role as an economic actor. One of the main goals of the government is to contribute to aggregate demand through the purchase of goods and services. Along with contributing to aggregate demand, the government has the important role of investing in infrastructure and new technologies and to foster science and education, important determinants of the long-term productivity development of an economy. A fundamentally important topic that unfortunately we do not address in this book. Figure 5.1 illustrates the importance of government demand as a component of overall aggregate demand. For most of the countries reported in the figure, government consumption expressed as share of GDP ranged from 10% to 25% over the period 1950 to 2017.
Figure 5.1: Government consumption as a share of GDP for selected countries. Source: Penn World Table 9.1 (Feenstra, Inklaar, and Timmer 2015). Note: Countries can be hidden by clicking on the legend. Double-clicking selects only one country.
In the context of the simple macroeconomic models that we will develop in the following chapters, we assume that government final demand for goods and services is an exogenous variable. This means that government spending is determined by the government, or the “treasury”, of our model economy. This condition can be summarised as follows:
\[\begin{equation} G = \overline{G} \tag{5.1} \end{equation}\]
We will assume that the government can vary its spending independently of tax revenues, since it can finance its purchases by borrowing from commercial banks or even from the central bank. As long as we do not make any further statements about tax revenues, we will assume that we are dealing with credit-financed government spending, in which case \(G\) is equivalent to the government budget deficit.