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Investment complementarities, coordination failure, and the role and effects of public investment policy

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  • Kasahara, Tetsuya
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    Abstract

    This paper analyzes the role and effects of public investment policy when coordination problems among agents can result in individually rational but socially inefficient investment decisions. Developing a coordination investment model in which individuals simultaneously and independently determine whether to undertake a risky but potentially more profitable investment project or an alternative with safe but lower returns, we first show that the risk of coordination failure can in equilibrium result in socially inefficient investment and small consumption. We then investigate the role and effects of a public investment policy designed to help mitigate inefficiency. In our model, the size of a feasible public investment policy is determined endogenously. Our numerical results show that the divisibility of investment projects, the presence of financial constraints, the productivity of public investments, and the relative precision of public and private information, as well as the relative tax rates imposed on risky investments and safe investments, have complex effects on the effectiveness of public investment policy and welfare. In particular, we demonstrate that a public investment policy of a larger size and the availability of more precise information do not necessarily increase welfare.

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    File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/25758/1/DP589.pdf
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    Bibliographic Info

    Paper provided by Institute of Economic Research, Hitotsubashi University in its series Discussion Paper Series with number 589.

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    Length: 35 p.
    Date of creation: Jun 2013
    Date of revision:
    Handle: RePEc:hit:hituec:589

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    Related research

    Keywords: Strategic complementarities; coordination games; information precision; public investment policy; financial constraints;

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    1. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
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    8. Heinemann, Frank & Illing, Gerhard, 2002. "Speculative attacks: Unique equilibrium and transparency," Munich Reprints in Economics 19430, University of Munich, Department of Economics.
    9. Chui, Michael & Gai, Prasanna & Haldane, Andrew G., 2002. "Sovereign liquidity crises: Analytics and implications for public policy," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 519-546, March.
    10. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2003. "Coordination and Policy Traps," NBER Working Papers 9767, National Bureau of Economic Research, Inc.
    11. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
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