Consumption and government spending substitutability revisited: Evidence from Taiwan

Bailey (1971) first documented the idea that there may be a degree of substitutability of the relationship between government spending and private consumption. In this paper, this is embedded in a Markov-switching framework where the relationship is subject to shifting between to different regimes. To control small-sample bias, the bootstrap maximum likelihood estimator is used. Evidence from Taiwan indicates that the crowding-in effect dominated the pre-1980 period; the substitutability dominates the post-1980 period. It renders unconvincing the Keynesian plea for expansionary fiscal policy of Taiwan since the 1980s. A Mundell-Fleming approach is proposed to explain this dating.