Persistence in government spending fluctuations: New evidence on the displacement effect

In spite of Peacock and Wiseman's 1961 NBER study demonstrating the “displacement effect”, simplistic theoretical and empirical distinctions between temporary and permanent spending are common. In this paper, impulse response functions from ARMA models as well as Cochrane's non-parametric method support Peacock and Wiseman's conclusion by showing 1) government spending in the aggregate displays strong persistence to temporary shocks, 2) simple decomposition methods intended to yield a “temporary” spending series have a weak statitistical foundation, and 3) persistence in spending has increased during this century. Also, as a basic “fact” of government spending behavior, the displacement effect lends support to interest group and bureaucracy models of government spending growth.