Working Paper: CEPR ID: DP6139
Authors: Mustafa Ismihan; F Gulcin Ozkan
Abstract: This paper explores the implications of public investment for macroeconomic performance within a simple two-period policymaking model. We show that under the balanced-budget rule, the contribution of public investment to future output plays a key role in determining its effects on macroeconomic performance. When policymakers resort to debt issue in financing expenditures, the attractiveness of public investment crucially depends on the return from capital spending relative to the cost of public borrowing. We also consider the case of a capital borrowing rule where only public investment could be financed by additional borrowing and find similar results. Our findings point to the key role of the quality of public investment in its impact on macroeconomic outcome and highlight the importance of efficient mechanisms for selection, implementation and monitoring of public investment projects in both developed and developing countries.
Keywords: macroeconomic performance; public debt; public investment
JEL Codes: E62; H50; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Quality of public investment (H54) | Macroeconomic performance (E66) |
| Public capital spending today raises future output (H54) | Public investment enhances overall performance (H54) |
| Rate of return on investment projects insufficient to cover costs of borrowing (G31) | Unfavorable effects on macroeconomic performance (E60) |
| Attractiveness of public investment contingent on return from capital spending relative to cost of public borrowing (H54) | Debt financing decisions (G32) |
| Public investment may yield unfavorable effects on macroeconomic performance if returns are low (H54) | Macroeconomic outcomes worsen (E66) |
| Increasing public investment without considering costs and benefits (H40) | Not a substitute for improving quality of public investment (H54) |