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Should the government increase investment in infrastructure improvements when interest rates decline?

Author

Listed:
  • Joshua R Hendrickson

    (University of Mississippi)

Abstract

During recessions, the real interest rate declines and therefore a number of public investment projects might meet the net present value criteria. It has been argued that the government should increase public investment during these times. This paper begins with the assumption that the projects that the government would undertake in these situations are likely to be infrastructure improvement projects. This paper then uses the option theory of investment to determine the criteria for investment. In particular, the government solves an optimal stopping problem. The paper shows that if the government uses the real interest rate to discount the future, the effect of falling real interest rates on investment thresholds is ambiguous. It is therefore not obvious that the government should increase public investment when the real interest rate declines.

Suggested Citation

  • Joshua R Hendrickson, 2015. "Should the government increase investment in infrastructure improvements when interest rates decline?," Economics Bulletin, AccessEcon, vol. 35(3), pages 1687-1692.
    • Handle: RePEc:ebl:ecbull:eb-15-00521
    as

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    References listed on IDEAS

    as
    1. Dennis R. Capozza & Yuming Li, 2001. "Residential Investment and Interest Rates: An Empirical Test of Land Development as a Real Option," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 29(3), pages 503-519, March.
    2. David Andolfatto, 2012. "Liquidity shocks, real interest rates, and global imbalances," Review, Federal Reserve Bank of St. Louis, vol. 94(May), pages 187-196.
    3. Selgin, George & Beckworth, David & Bahadir, Berrak, 2015. "The productivity gap: Monetary policy, the subprime boom, and the post-2001 productivity surge," Journal of Policy Modeling, Elsevier, vol. 37(2), pages 189-207.
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    JEL classification:

    • H5 - Public Economics - - National Government Expenditures and Related Policies

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