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Government Investment, Its Financing and the Public Capital Stock: A Small Open Economy Perspective

Rónán Hickey, Matija Lozej and Diarmaid Smyth
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Rónán Hickey: Central Bank of Ireland
Diarmaid Smyth: Department of Finance

No 9/RT/19, Research Technical Papers from Central Bank of Ireland

Abstract: Expenditure reductions played a key role in many small open economies during the fiscal consolidation between 2008 to 2013, especially for public investment. This led to lower public capital stock and affected competitiveness of these countries. After the crisis, many governments consider increasing government investment to replenish the public capital stock, but have limited resources to do so. This paper shows that budget-neutral investment spending can generate the long-term benefits of a higher public capital stock while at the same time limiting the risks of overheating and negative consequences for public finances and trade balance. The least harmful way of financing government investment, which preserves both fiscal and external balances, is by reducing other government spending, even if it is valued by households. Financing government investment with debt worsens fiscal and external balances. Financing investment with labour taxes reduces the external balance, while financing with VAT only does so in the very short run.

Keywords: DSGE models; government investment; public finances; monetary union; open-economy macroeconomics. (search for similar items in EconPapers)
JEL-codes: F16 F41 F42 F45 F47 (search for similar items in EconPapers)
Date: 2019-08
New Economics Papers: this item is included in nep-dge and nep-opm
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