PRIVATE AND GOVERNMENT CONSUMPTION WITH LIQUIDITY CONSTRAINTS

Economic theory predicts that liquidity constraints and substitutabili ty or complementarity between private and government consumption resul t in excess sensitivity of private consumption to income and governmen t consumption, respectively. Using annual data, we estimate these exce ss sensitivity parameters for each of 54 countries and show that they not only have sensible values but are also correlated with several var iables in ways consistent with economic theory. Our findings imply tha t the degree of substitutability between government services and priva te consumption depends negatively on the fraction of government spendi ng that goes to national defense. We also find that liquidity constrai nts typically exist and they are affected positively by output variabi lity and negatively by the saving rate. Copyright (C) 1996 Elsevier Sc ience Lid.