Government consumption and the composition of private expenditure: A conditional error correction model

In this paper we provide empirical evidence of the relationship between government purchases and private expenditure by adopting a microeconomic approach. Using UK quarterly data, a long-run demand system conditioned to the public sector is obtained by specifying a vector error correction model in which government consumption is assumed as an exogenous I(1) forcing variable. Our findings reject the hypothesis of separability of individual preferences between public and private expenditures, with simultaneous crowding-out/in effects. Moreover, crowding-out effects of government consumption on private spending are found to be larger for those goods and services that produce similar utility.