Government Expenditure

Definition and Role

Government expenditure, or G, is spending by the government on goods and services, including public services, and infrastructure.

It is a key component of aggregate demand: AD = C + I + G + (X - M).

Governments use expenditure to pursue both macroeconomic and microeconomic objectives.

Key Influences on Government Spending

The Economic Cycle (Automatic Stabilisers)

Government spending changes automatically over the business cycle and helps stabilise the economy.

In a recession or weak economy: Spending increases as welfare claims rise, while tax revenues fall. This automatic fiscal stimulus helps support aggregate demand.

In a boom or strong economy: Spending decreases as welfare claims fall, while tax revenues rise. This automatic fiscal contraction helps cool the economy.

Discretionary Fiscal Policy

Governments can make discretionary changes to spending to meet policy aims.

Expansionary Fiscal Policy: Increasing G, for example on infrastructure or education, to boost aggregate demand, growth, and employment.

Contractionary Fiscal Policy: Decreasing G to reduce aggregate demand, control inflation, or reduce a budget deficit.

Political and Social Priorities

Government spending also reflects wider priorities that can change over time.

Long-term Supply-Side Policies: Spending on infrastructure, education, and healthcare can increase productive potential and shift LRAS to the right.

Political Promises: Spending may reflect manifesto commitments, such as higher defence spending or new hospitals.

Demographic Changes: An ageing population can increase government spending on pensions and healthcare.

Impact of Changes in Government Spending

On AD: An increase in government spending directly raises aggregate demand and may increase real GDP, employment, and inflation depending on the amount of spare capacity.

On LRAS: Spending on infrastructure, education, and technology can increase productive capacity and shift long-run aggregate supply to the right.