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

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  • Kasahara, Tetsuya

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.

Suggested Citation

  • Kasahara, Tetsuya, 2013. "Investment complementarities, coordination failure, and the role and effects of public investment policy," Discussion Paper Series 589, Institute of Economic Research, Hitotsubashi University.
  • Handle: RePEc:hit:hituec:589
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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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    References listed on IDEAS

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    1. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2003. "Coordination and Policy Traps," NBER Working Papers 9767, National Bureau of Economic Research, Inc.
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    6. Morris, Stephen & Shin, Hyun Song, 2004. "Coordination risk and the price of debt," European Economic Review, Elsevier, vol. 48(1), pages 133-153, February.
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    More about this item

    Keywords

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

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H53 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Welfare Programs

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