Public infrastructure investment, output dynamics, and balanced budget fiscal rules

Pedro Bom and Jenny Ligthart

Journal of Economic Dynamics and Control, 2014, vol. 40, issue C, 334-354

Abstract: We study the dynamic macroeconomic effects of public infrastructure investment under a balanced budget fiscal rule, using an overlapping generations model of a small open economy. The government finances public investment by employing distortionary labor taxes. The balanced budget rule implies a negative short-run output multiplier that exceeds (in absolute terms) the positive long-run output multiplier. Larger public capital spillovers sharpen the intertemporal output tradeoff. In contrast to conventional results regarding public investment shocks, we obtain dampened cyclical responses for plausible parameter values. The cyclical dynamics arise from the interaction between the labor tax rate, the tax base, and the intergenerational spillover effects. We show that financing scenarios involving public debt creation can substantially reduce the short-run output contraction and the transitional macroeconomic fluctuations induced by public investment.

Keywords: Public infrastructure investment; Distortionary taxation; Balanced budget fiscal rules (search for similar items in EconPapers)
JEL-codes: E62 F41 H54 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (36)

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Working Paper: Public Infrastructure Investment, Output Dynamics, and Balanced Budget Fiscal Rules (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:40:y:2014:i:c:p:334-354

DOI: 10.1016/j.jedc.2014.01.018

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