SEM analysis of public spending and federal grants-in-aid in the US using the Pindyck-Rubinfeld model

Level of economic growth is directly affected by government spending and one of the most important forms of spending is the federal grants-in-aid. Not only does this help the improvement of infrastructures, but also the improvement of human resources, enhancing economic growth. Given the importance of government spending on economic growth of a country, this research used the Pindyck-Rubinfeld model of public spending and federal grants-in-aid as the basis model for data collection and simultaneous equation model (SEM) analysis. The results show that there is a simultaneity problem between government spending and federal grants-in-aid affect and the equations are both identified. Thus, the estimating model is built by using the 2SLS method. The model generates a very high accuracy, but the diagnostic tests do not meet all the required conditions, resulting in a need of transformation of the model. The transformed model turns out to also generate a very high accuracy, indicating that the new transformed Pindyck-Rubinfeld model of public spending and federal grants-in-aid can be applied to solve real life economic problems in estimating the US government expenditure or the federal grants-in-aid.