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Fiscal rules and the intergenerational welfare effects of public investment

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  • Bom, Pedro R.D.

Abstract

A common argument against balanced-budget fiscal rules has it that the costs of durable public capital fall entirely on current generations while its benefits also accrue to future generations. This paper proposes an additional argument whereby balanced-budget rules imply uneven welfare effects of public investment across generations. Using an overlapping generations model of a small open economy, I show that, when subject to a balanced-budget constraint, public investment causes a negative financial wealth effect on current generations. Numerical simulations of the model show that, in terms of welfare, this negative financial wealth effect more than offsets the productivity gains of higher public investment spending, leaving current generations worse-off. A golden rule exempting net public investment from the balanced-budget requirement overturns this effect and allows for welfare gains to both current and future generations. Allowing for debt-financing may thus be necessary to ensure public support for efficient increases in public investment spending.

Suggested Citation

  • Bom, Pedro R.D., 2019. "Fiscal rules and the intergenerational welfare effects of public investment," Economic Modelling, Elsevier, vol. 81(C), pages 455-470.
    • Handle: RePEc:eee:ecmode:v:81:y:2019:i:c:p:455-470
    DOI: 10.1016/j.econmod.2018.02.002
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    Cited by:

    1. Brändle, Thomas & Elsener, Marc, 2023. "Do fiscal rules matter? A survey on recent evidence," Working papers 2023/07, Faculty of Business and Economics - University of Basel.
    2. Bom, Pedro R.D. & Erauskin, Iñaki, 2022. "Productive government investment and the labor share," International Review of Economics & Finance, Elsevier, vol. 82(C), pages 347-363.
    3. Bechlioulis, Alexandros P. & Brissimis, Sophocles N., 2021. "Identifying key aspects of household behavior in a representative agent framework," Economic Modelling, Elsevier, vol. 97(C), pages 105-117.
    4. Giménez-Nadal, José Ignacio & Molina, José Alberto & Velilla, Jorge, 2022. "Intergenerational correlation of self-employment in Western Europe," Economic Modelling, Elsevier, vol. 108(C).
    5. Sebastian Blesse & Florian Dorn & Max Lay, 2023. "Do Fiscal Rules Undermine Public Investments? A Review of Empirical Evidence," ifo Working Paper Series 393, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    6. Ryota Nakatani, 2019. "A Possible Approach to Fiscal Rules in Small Islands — Incorporating Natural Disasters and Climate Change," IMF Working Papers 2019/186, International Monetary Fund.
    7. Ryota Nakatani, 2021. "Fiscal Rules for Natural Disaster- and Climate Change-Prone Small States," Sustainability, MDPI, vol. 13(6), pages 1-26, March.

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    More about this item

    Keywords

    Balanced-budget rule; Golden rule; Intergenerational welfare; Public investment; Public capital;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures

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