Prosperity or Stagnation: The Role of Government Expenditures

The focus of this paper is to examine the effects and mechanism of government expenditures (GEs) in determining the long-term inflation differentials across countries. For this purpose, we formulate a theoretical model and the related regression system. The models allow us to understand and quantify the supply-side (SS) and demand-side (DS) effects of GEs in determining prosperity or stagnation across countries. This study provides cross-country evidences and related mechanisms supporting the hypothesis and conclusion that active short-term AD policies and over-estimated potential output, as argued in Orphanides (2003), were contributive to the Great Inflation.