Local spending and the housing boom

We study the inter-temporal spending behavior of Spanish local governments during the last housing boom (1997-2006), a period of substantial short-run momentum in housing-construction revenues. We argue that the unprecedented growth in these revenues might be one of the reasons underlying the increase in the sensitivity of local government spending to (predictable) revenue changes. To detect evidence of this, we study whether local spending decisions are consistent with forward-looking behavior, working within the framework provided by Holtz-Eakin et al. (1994). Our principal findings are: (i) Local spending shows substantial sensitivity to predictable changes in revenues, suggesting that Spanish local governments did not behave as fully forward-looking agents. (ii) The departure from this benchmark was much higher in those years and/or in those housing markets in which the housing boom was most intense. (iii) The sensitivity was not as great to changes in housing construction revenues as it was to changes in ordinary revenues, but this distinction became blurred as the boom intensified.