Financing government investment and its implications for public capital: A small open economy perspective |
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| Institution: | 1. Central Bank of Ireland, Irish Economic Analysis, New Wapping Street, North Wall Quay, Dublin 1, Ireland;2. Central Bank of Ireland, Irish Economic Analysis, Macro Modelling, New Wapping Street, North Wall Quay, Dublin 1, Ireland;3. Department of Finance, Government Buildings, Upper Merrion Street, Dublin 2, Ireland;1. Narodowy Bank Polski, Poland;2. University of Lodz, Poland;1. Aletheia University, Taiwan;2. National Taichung University of Science and Technology, Taiwan;1. China Economics and Management Academy, Central University of Finance and Economics, No. 39 South College Road, Haidian District, 100081 Beijing, China;2. School of Finance, Jiangxi University of Finance and Economics, Nanchang, China;3. School of Economics, Jiangxi University of Finance and Economics, Nanchang, 330013, China;1. IMUVa, Universidad de Valladolid, Spain;2. Universidad de Murcia, Spain |
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| Abstract: | Expenditure reductions played a key role in many small open economies during fiscal consolidation, with large declines in public investment. This led to a reduction in public capital stock and affected the competitiveness of these economies. After the sovereign debt crisis, the governments that consider increasing investment to replenish the public capital stock have limited fiscal space and have to avoid external imbalances. We show that using budget-neutral investment spending can generate long-term benefits of higher public capital stock while at the same time limiting negative consequences for the public finances and the trade balance. The best way of financing government investment, which preserves fiscal and trade balances, and increases welfare, is by reducing other government spending. The second-best is financing investment with value-added tax. Financing with debt worsens fiscal and trade balances, while using distortionary labour taxes reduces labour supply, increases wage costs and worsens the trade deficit in the short run. |
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| Keywords: | DSGE models Government investment Public finance Monetary union Open-economy macroeconomics F16 F41 F42 F45 F47 |
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