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Assessing the Impact of a Change in the Composition of Public Spending

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Author Info

  • Ivan Tchakarov
  • Roland Straub

Abstract

Despite intense calls for safeguarding public investment in Europe, public investment expenditure, when measured in relation to GDP, has steadily fallen in the last three decades, evoking fears that economic activity may be correspondingly negatively affected. At the same time, however, public consumption in the EU-12 countries has trended up. In this paper, we provide a macroeconomic assessment of the observed change in the composition of public spending in the euro area in a medium-scale two-country dynamic stochastic general equilibrium (DSGE) model. First, we identify the channels through which both temporary and permanent public investment shocks generate larger fiscal multipliers than exogenous increases in public consumption. Second, we quantify the negative impact of a change in fiscal stance, characterized by a permanent rise in public consumption and a permanent fall in public investment, keeping the overall level of public spending constant. The key message of the paper is that calls for reversing the observed trend in the composition of public spending are well justified.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/168.

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Length: 47
Date of creation: 01 Jul 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/168

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Keywords: Public investment; Government expenditures; Economic models; European Union; private investment; private capital; competitive markets; budget constraint; tax rate; foreign currency; fixed capital; level of public spending; gross fixed capital formation; liquidity constraints; government budget constraint; national accounts; public finances; tax revenue; risk ? premium; public investment spending; rates of return; international finance; public investment expenditures; investment spending; capital expenditure; investment expenditures; investment flows; cost of capital; budgetary deficits;

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References

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  1. Jordi Galí & J. David López-Salido & Javier Vallés, 2007. "Understanding the Effects of Government Spending on Consumption," Journal of the European Economic Association, MIT Press, MIT Press, vol. 5(1), pages 227-270, 03.
  2. Ward Romp & Jakob de Haan, 2007. "Public Capital and Economic Growth: A Critical Survey," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, Verein für Socialpolitik, vol. 8(s1), pages 6-52, 04.
  3. Jakob Haan & Jan Sturm & Bernd Sikken, 1996. "Government capital formation: Explaining the decline," Review of World Economics (Weltwirtschaftliches Archiv), Springer, Springer, vol. 132(1), pages 55-74, March.
  4. David Aschauer, 1988. "Is public expenditure productive?," Staff Memoranda, Federal Reserve Bank of Chicago 88-7, Federal Reserve Bank of Chicago.
  5. Coenen, Günter & McAdam, Peter & Straub, Roland, 2007. "Tax reform and labour-market performance in the euro area: a simulation-based analysis using the New Area-Wide Model," Working Paper Series, European Central Bank 0747, European Central Bank.
  6. Roberto Perotti, 2004. "Public investment: another (different) look," Working Papers 277, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  7. Valila, Timo & Mehrotra, Aaron, 2005. "Evolution And Determinants Of Public Investment In Europe," Economic and Financial Reports, European Investment Bank, Economics Department 2005/1, European Investment Bank, Economics Department.
  8. Evi Pappa, 2005. "New Keynesian or RBC Transmission? The Effects of Fiscal Policy in Labor Markets," Working Papers 293, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  9. Günter Coenen & Roland Straub, 2005. "Does Government Spending Crowd in Private Consumption? Theory and Empirical Evidence for the Euro Area," International Finance, Wiley Blackwell, Wiley Blackwell, vol. 8(3), pages 435-470, December.
  10. David A. Aschauer, 1989. "Public investment and productivity growth in the Group of Seven," Economic Perspectives, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue Sep, pages 17-25.
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Citations

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Cited by:
  1. Guillem López Casasnovas, 2010. "La calidad del gasto público y su influencia en el desarrollo económico: una validación empírica para los países de la OCDE 1970-2005," Hacienda Pública Española, IEF, IEF, vol. 193(2), pages 9-48, June.
  2. Nikolai Stähler & Carlos Thomas, 2011. "FiMod - a DSGE model for fiscal policy simulations," Banco de Espa�a Working Papers 1110, Banco de Espa�a.
  3. Stančík, Juraj & Välilä, Timo, 2010. "changes in the fiscal stance and the composition of public spending," Economic and Financial Reports, European Investment Bank, Economics Department 2010/2, European Investment Bank, Economics Department.
  4. repec:dgr:uvatin:2010021 is not listed on IDEAS
  5. Francisco de Castro & Laura Fernández-Caballero, 2011. "The effects of fiscal shocks on the exchange rate in Spain," Banco de Espa�a Working Papers 1121, Banco de Espa�a.
  6. Coenen, Günter & Mohr, Matthias & Straub, Roland, 2008. "Fiscal consolidation in the euro area: Long-run benefits and short-run costs," Economic Modelling, Elsevier, Elsevier, vol. 25(5), pages 912-932, September.
  7. Forni, Lorenzo & Gerali, Andrea & Pisani, Massimiliano, 2010. "The macroeconomics of fiscal consolidations in euro area countries," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(9), pages 1791-1812, September.
  8. Rochelle M. Edge & Jeremy B. Rudd, 2010. "General-equilibrium effects of investment tax incentives," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2010-17, Board of Governors of the Federal Reserve System (U.S.).
  9. Carine Bouthevillain & John Caruana & Cristina Checherita & Jorge Cunha & Esther Gordo & Stephan Haroutunian & Amela Hubic & Geert Langenus & Bernhard Manzke & Javier J. Pérez & Pietro Tommasino, 2009. "Pros and Cons of various fiscal measures to stimulate the economy," BCL working papers, Central Bank of Luxembourg 40, Central Bank of Luxembourg.
  10. Christoph Priesmeier & Nikolai Stähler, 2011. "Long Dark Shadows Or Innovative Spirits? The Effects Of (Smoothing) Business Cycles On Economic Growth: A Survey Of The Literature," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 25(5), pages 898-912, December.

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