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Public Infrastructure Investment, Output Dynamics, and Balanced Budget Fiscal Rules

  • Pedro R. D. Bom

    ()

    (Department of Economics and CentER, Tilburg, University)

  • Jenny Ligthart

    ()

    (Department of Economics and CentER, Tilburg, University)

We study the dynamic output and welfare effects of public infrastructure investment under a balanced budget fiscal rule, using an overlapping generations model of a small open economy. The government finances public investment by employing distortionary labor taxes. We find a negative short-run output multiplier, which (in absolute terms) exceeds the positive long-run output multiplier. In contrast to conventional results regarding public investment shocks, we obtain dampened cycles in output and the labor tax rate. The cyclical dynamics are induced by the interaction of households' finite life spans, the wealth effect on labor supply, and the balanced budget fiscal rule. Finally, we show that, for a plausible calibration of our model, households' lifetime welfare improves.

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File URL: http://icepp.gsu.edu/files/2015/03/ispwp1119.pdf
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Paper provided by International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University in its series International Center for Public Policy Working Paper Series, at AYSPS, GSU with number paper1119.

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Length: 43 pages
Date of creation: 23 Aug 2011
Date of revision:
Handle: RePEc:ays:ispwps:paper1119
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Web page: http://aysps.gsu.edu/isp/index.html

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