Costly Capital Reallocation and the Effects of Government Spending
NBER Working Paper No. 6283 (Also Reprint No. r2225)
Changes in government spending often lead to significant shifts in demand across sectors. This paper analyzes the effects of sector-specific changes in government spending in a two-sector dynamic general equilibrium model in which the reallocation of capital across sectors is costly. The two-sector model leads to a richer array of possible responses of aggregate variables than the one-sector model. The empirical part of the paper estimates the effects of military buildups on a variety of macroeconomic variables using a new measure of military shocks. The behavior of macroeconomic aggregates is consistent with the predictions of a multi-sector neoclassical model. In particular, consumption, real product wages and manufacturing productivity fall in response to exogenous military buildups in the post-World War II United States.
Published: Carnegie-Rochester Conference Series on Public Policy, vol. 48, 1998, pp. 1 145-194