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Government Investment, Its Financing and the Public Capital Stock: A Small Open Economy Perspective

Author

Listed:
  • Hickey, Rónán

    (Central Bank of Ireland)

  • Lozej, Matija

    (Central Bank of Ireland)

  • Smyth, Diarmaid

    (Department of Finance)

Abstract
Expenditure reductions played a key role in many small open economies during the fiscal consolidation between 2008 to 2013, especially for public investment. This led to lower public capital stock and affected competitiveness of these countries. After the crisis, many governments consider increasing government investment to replenish the public capital stock, but have limited resources to do so. This paper shows that budget-neutral investment spending can generate the long-term benefits of a higher public capital stock while at the same time limiting the risks of overheating and negative consequences for public finances and trade balance. The least harmful way of financing government investment, which preserves both fiscal and external balances, is by reducing other government spending, even if it is valued by households. Financing government investment with debt worsens fiscal and external balances. Financing investment with labour taxes reduces the external balance, while financing with VAT only does so in the very short run.

Suggested Citation

  • Hickey, Rónán & Lozej, Matija & Smyth, Diarmaid, 2019. "Government Investment, Its Financing and the Public Capital Stock: A Small Open Economy Perspective," Research Technical Papers 9/RT/19, Central Bank of Ireland.
    • Handle: RePEc:cbi:wpaper:9/rt/19
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    More about this item

    Keywords

    DSGE models; government investment; public finances; monetary union; open-economy macroeconomics.;
    All these keywords.

    JEL classification:

    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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