Optimal Public Investment with and Without Government Commitment

Federal Reserve Bank of Richmond Working Paper No. 03-10

42 Pages Posted: 6 Apr 2005

See all articles by Pierre-Daniel G. Sarte

Pierre-Daniel G. Sarte

Federal Reserve Bank of Richmond

Marina Azzimonti

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

Jorge Soares

University of Delaware

Multiple version iconThere are 2 versions of this paper

Date Written: August 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. Interestingly, 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. We also show that the inability to commit to future policy generally implies, surprisingly, lower taxes and too little public investment in the long run. Finally, in contrast to previous work, 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

Sarte, Pierre-Daniel and Azzimonti, Marina and Soares, Jorge, Optimal Public Investment with and Without Government Commitment (August 2003). Federal Reserve Bank of Richmond Working Paper No. 03-10. Available at SSRN: https://ssrn.com/abstract=689145 or http://dx.doi.org/10.2139/ssrn.689145

Pierre-Daniel Sarte (Contact Author)

Federal Reserve Bank of Richmond ( email )

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

Marina Azzimonti

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

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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