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

See all articles by Pedro Bom

Pedro Bom

Tilburg University - Center and Faculty of Economics and Business Administration

Jenny E. Ligthart

Tilburg University - CentER, Department of Economics; University of Groningen - Faculty of Economics and Business; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: August 17, 2011

Abstract

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

Bom, Pedro and Ligthart, Jenny E., Public Infrastructure Investment, Output Dynamics, and Balanced Budget Fiscal Rules (August 17, 2011). CentER Working Paper Series No. 2011-092. Available at SSRN: https://ssrn.com/abstract=1911164 or http://dx.doi.org/10.2139/ssrn.1911164

Pedro Bom

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Jenny E. Ligthart (Contact Author)

Tilburg University - CentER, Department of Economics ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 8755 (Phone)
+31 13 466 4032 (Fax)

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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