Public Infrastructure Investment, Output Dynamics, and Balanced Budget Fiscal Rules
CentER Working Paper Series No. 2011-092
44 Pages Posted: 17 Aug 2011 Last revised: 19 Aug 2011
Date Written: August 17, 2011
We study the dynamic output and welfare 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. We find a negative short-run output multiplier, which (in absolute terms) exceeds the positive long-run output multiplier. In contrast to conventional results regarding public investment shocks, we obtain dampened cycles in output and the labor tax rate. The cyclical dynamics are induced by the interaction of households' finite life spans, the wealth effect on labor supply, and the balanced budget fiscal rule. Finally, we show that, for a plausible calibration of our model, households' lifetime welfare improves.
Keywords: infrastructure capital, public investment, distortionary taxation, fiscal policy, Yaari-Blanchard overlapping generations
JEL Classification: E62, F41, H54
Suggested Citation: Suggested Citation