The production of national defense and the macroeconomy.

Abstract

This study investigates the interactions between defense production and the rest of the economy. We develop a two-sector dynamic stochastic general equilibrium model with military and nonmilitary production. Inputs (capital and labor) are distributed between the two sectors. Calibration of the model to key targets of the US economy results in an elasticity of substitution between consumption of goods and services and national defense services of 0.56. The estimated complementarity between consumption goods and defense services results in positive spillovers across military and final goods production sectors, even when the nonmilitary production function is not directly related to military spending. We find that military spending is procyclical and that military spending as a percentage of output is countercyclical. Finally, investment-specific technological shocks to military equipment have a positive impact on nonmilitary output, although they reduce business investment.