 Financing government investment and its implications for public capital: A small open economy perspectiveRónán Hickey, Matija Lozej and Diarmaid Smyth Economic Modelling, 2020, vol. 93, issue C, 620-641 Abstract: Expenditure reductions played a key role in many small open economies during fiscal consolidation, with large declines in public investment. This led to a reduction in public capital stock and affected the competitiveness of these economies. After the sovereign debt crisis, the governments that consider increasing investment to replenish the public capital stock have limited fiscal space and have to avoid external imbalances. We show that using budget-neutral investment spending can generate long-term benefits of higher public capital stock while at the same time limiting negative consequences for the public finances and the trade balance. The best way of financing government investment, which preserves fiscal and trade balances, and increases welfare, is by reducing other government spending. The second-best is financing investment with value-added tax. Financing with debt worsens fiscal and trade balances, while using distortionary labour taxes reduces labour supply, increases wage costs and worsens the trade deficit in the short run. Keywords: DSGE models; Government investment; Public finance; Monetary union; Open-economy macroeconomics (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:93:y:2020:i:c:p:620-641 DOI: 10.1016/j.econmod.2020.08.006 Access Statistics for this article Economic Modelling is currently edited by S. Hall and P. Pauly More articles in Economic Modelling from Elsevier |
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