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Impact of Public Investment Upon Economic Performance and Budgetary Consolidation Efforts in the European Union

  • Alfredo Marvao Pereira

    ()

  • Maria De Fatima Pinho

    ()

In an period of heightened concern about fiscal consolidation in the Euro zone, a politically expedient way of dealing with the situation is to cut public investment. A critical question, however, is whether or not political expediency comes at a cost, in terms of both long-term economic performance and future budgetary consolidation efforts. In fact, one would expect any type of investment, including public investment, to improve the long-term economic performance. Moreover, to the extent that public investment increases output in the long-term, it also expands the tax base and, therefore, tax revenues in the long term. It is conceivable that public investment has such strong effects on output, that over time it generates enough additional tax revenues to pay for itself. It is equally plausible that the effects on output although positive are not strong enough for the public investment to pay for itself. In the first case, cuts in public investment hurt long-term growth and make the future budgetary situation worse. In the second case, cuts in public investment hurt the long-term economic performance without hurting the future budgetary situation. In this paper we investigate this question empirically in the context of a number of countries in the Euro zone using a vector auto-regressive/error correction mechanism approach to determine the effects of aggregated public investment on output, employment and private investment. Our ultimate objective is to determine in which regime do the different countries seem to fit and determine to what extent cuts in public investment may turn out to be counter-productive in the long-term from a budgetary perspective. JEL Classification: C32, E62, H54, O52

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Paper provided by European Regional Science Association in its series ERSA conference papers with number ersa06p122.

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Date of creation: Aug 2006
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Handle: RePEc:wiw:wiwrsa:ersa06p122
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  1. Glenn D. Rudebusch, 1996. "Do measures of monetary policy in a VAR make sense?," Working Papers in Applied Economic Theory 96-05, Federal Reserve Bank of San Francisco.
  2. Gonzalo, J. & Lee, T.H., 1995. "Pitfalls in Testing for Long Run Relationships," Papers 38, Boston University - Department of Economics.
  3. Alfredo M. Pereira & Jorge M. Andraz, 2005. "Public Investment in Transportation Infrastructure and Economic Performance in Portugal," Review of Development Economics, Wiley Blackwell, vol. 9(2), pages 177-196, 05.
  4. Alfredo M. Pereira, 2000. "Is All Public Capital Created Equal?," The Review of Economics and Statistics, MIT Press, vol. 82(3), pages 513-518, August.
  5. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  6. Alicia H. Munnell, 1992. "Policy Watch: Infrastructure Investment and Economic Growth," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 189-198, Fall.
  7. Gramlich, Edward M, 1994. "Infrastructure Investment: A Review Essay," Journal of Economic Literature, American Economic Association, vol. 32(3), pages 1176-96, September.
  8. David Aschauer, 1988. "Is public expenditure productive?," Staff Memoranda 88-7, Federal Reserve Bank of Chicago.
  9. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
  10. David Aschauer, 1988. "Does public capital crowd out private capital?," Staff Memoranda 88-10, Federal Reserve Bank of Chicago.
  11. Hulten, Charles R. & Schwab, Robert M., 1993. "Infrastructure Spending: Where Do We Go From Here?," National Tax Journal, National Tax Association, vol. 46(3), pages 261-73, September.
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