Should the government increase investment in infrastructure improvements when interest rates decline?

Joshua Hendrickson

Economics Bulletin, 2015, vol. 35, issue 3, 1687-1692

Abstract: During recessions, the real interest rate declines and therefore a number of public investment projects might meet the net present value criteria. It has been argued that the government should increase public investment during these times. This paper begins with the assumption that the projects that the government would undertake in these situations are likely to be infrastructure improvement projects. This paper then uses the option theory of investment to determine the criteria for investment. In particular, the government solves an optimal stopping problem. The paper shows that if the government uses the real interest rate to discount the future, the effect of falling real interest rates on investment thresholds is ambiguous. It is therefore not obvious that the government should increase public investment when the real interest rate declines.

Keywords: optimal stopping time; public infrastructure; government spending; interest rates (search for similar items in EconPapers)
JEL-codes: H5 (search for similar items in EconPapers)
Date: 2015-08-12
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