What Are Government Purchases?
Government purchases are expenditures on goods and services by federal, state, and local governments. The combined total of this spending, excluding transfer payments and interest on the debt, is a key factor in determining a nation's gross domestic product (GDP). Transfer payments are expenditures that do not involve purchases, such as Social Security payments and farm subsidies.
- Government purchases include any spending by federal, state, and local agencies, with the exception of debt and transfer payments such as Social Security.
- Overall, government purchases are a key component of a nation's gross domestic product (GDP).
- According to the Keynesian theory of economics, government purchases are a tool to boost overall spending and correct a weak economy.
Understanding Government Purchases
One method of calculating GDP, a measure of the market value of all the final goods and services produced in a specific time period within a country's borders that's used to track the health of a nation's economy, is to add up all spending in four major categories:
- Personal consumption
- Business investment spending
- Government purchases
- Net exports
The U.S. Bureau of Economic Analysis (BEA) has a number of sub-categories. For instance, it breaks down government purchases into federal, state, and local spending and also differentiates defense-related federal spending from all other spending. The total for imported goods is subtracted from the final GDP total.
Government purchases have risen in real terms over recent decades:
As a share of overall nominal GDP, however, nominal government purchases have been falling:
Government purchases are seen as a crucial element of a healthy economy in Keynesian economic theory. That is, increasing or decreasing government spending is viewed as a key tool for regulating the business cycle.
According to this theory, government spending boosts demand in two ways. First, the government directly boosts demand by purchasing goods, such as the steel needed to build a bridge. Secondly, it puts money in the pockets of both workers and suppliers, who then spend it on goods and services. This is known as the multiplier effect.
Plenty of other economists are against the government spending lots of money, arguing that such action distorts interest rates, props up non-competitive firms, and leads to higher taxes and so forth.
Types of Government Purchases
Government purchases range from spending on infrastructure projects and paying civil service and public service employees, to buying office software and equipment and maintaining public buildings. Transfer payments, which do not involve purchases, are not included in this category.
The BEA attributed a rise in federal government spending in 2020 mainly to an increase in purchases of intermediate services to support the processing and administration of Paycheck Protection Program loan applications.
In 2020, the BEA revealed that federal government spending rose, while state and local government spending fell. Overall, real GDP, in a year overshadowed by crisis and the economically damaging lockdown measures, was estimated to have fallen by 3.5%.