Optimal Public Investment with and without Government Commitment

FRB Richmond Working Paper No. 03-10

38 Pages Posted: 3 Dec 2012

See all articles by Marina Azzimonti

Marina Azzimonti

SUNY Stony Brook - Department of Economics; National Bureau of Economic Research (NBER)

Pierre-Daniel G. Sarte

Federal Reserve Bank of Richmond

Jorge Soares

University of Delaware

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2003

Abstract

We analyze the problem of optimal public investment when government purchases of productive capital assets are financed through income taxes. Virtually all previous work in this literature has prescribed a share of public investment in GDP that is both constant and time consistent. This paper shows that this straightforward prescription derives from specific assumptions relating to preferences and technology. In a more general framework, the optimal policy is neither constant nor time consistent. With full commitment, a policymaker will typically choose a tax rate, or alternatively a share of public investment, that increases over time. He does not exploit the first-period non-distortionary tax on capital but instead delays taxation in order to generate a "take-off" phase with higher consumption and higher private investment. When optimal policy is constrained to be time consistent, long-run tax rates surprisingly emerge to be lower than under the Ramsey plan. Therefore, the inability to commit to future policy implies too little public investment in the long run. Finally, in contrast to previous work, we find that the efficient share of public investment in GDP depends importantly on the intertemporal elasticity of substitution, capital depreciation rates, and the growth rates of productivity and population.

Keywords: public investment, commitment, time consistency, discretion

JEL Classification: E61, E62, H11

Suggested Citation

Azzimonti, Marina and Sarte, Pierre-Daniel and Soares, Jorge, Optimal Public Investment with and without Government Commitment (August 1, 2003). FRB Richmond Working Paper No. 03-10. Available at SSRN: https://ssrn.com/abstract=2184515 or http://dx.doi.org/10.2139/ssrn.2184515

Marina Azzimonti (Contact Author)

SUNY Stony Brook - Department of Economics ( email )

NY 11733-4384
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pierre-Daniel Sarte

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Jorge Soares

University of Delaware ( email )

Department of Economics
Purnell Hall Room 315
Newark, DE 19716
United States
(302) 831 1914 (Phone)
(302) 831 6968 (Fax)

HOME PAGE: http://udel.edu/~jsoares

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