• Infrastructure-based Stimulus

    highway-bill

    Sylvain Leduc and Daniel Wilson have this very interesting recent paper on the impact of infrastructure spending over the economic cycle.

    We examine the dynamic macroeconomic effects of public infrastructure investment both theoretically and empirically, using a novel data set we compiled on various highway spending measures. Relying on the institutional design of federal grant distributions among states, we construct a measure of government highway spending shocks that captures revisions in expectations about future government investment. We find that shocks to federal highway funding has a positive effect on local GDP both on impact and after 6 to 8 years, with the impact effect coming from shocks during (local) recessions. However, we find no permanent effect (as of 10 years after the shock). Similar impulse responses are found in a number of other macroeconomic variables. The transmission channel for these responses appears to be through initial funding leading to building, over several years, of public highway capital which then temporarily boosts private sector productivity and local demand. To help interpret these findings, we develop an open economy New Keynesian model with productive public capital in which regions are part of a monetary and fiscal union. We show that the presence of productive public capital in this model can yield impulse responses with the same qualitative pattern that we find empirically.

    While I have until now been quite sceptical of the macro literature on the impact of infrastructure investment on growth (I reviewed it in this paper, working paper version here), this contribution is a huge improvement, in particular because of its ability to exploits the formula-based mechanism governing the apportionment of federal highway funds to state governments as a way to identify an exogenous source of highway funding to states, which is reasonably independent of states’ own current economic conditions. The results, in terms of cyclicality of impact and recession vs. expansion effect, have quite interesting implications for the current debate on austerity vs. stimulus plans:

    (…) we find that highway spending shocks positively affect GDP at two specific horizons. There is a significant impact in the first couple of years and then a larger second-round effect after six to eight years. The multipliers that we calculate from these impulse responses are large, between 1 and 3 on impact and between 3 and 7 at six to eight years out. Other estimates of local fiscal multip liers tend to be between 1 and 2.
    We looked at three extensions that relate to the important current policy debate over the efficacy of countercyclical fiscal policy. Infrastructure spending, because it is perceived as being more productive (in the sense of increasing private sector productivity) than other types of spending, is often pointed to as
    an attractive form of Keynesian spending. However, critics argue that the long lags between increases in infrastructure funding and actual spending make it unlikely that such spending can provide short-run stimulus. The results in this paper can help inform this debate. We found that, on average over our 1993–2010 sample period, unanticipated funding increases in a given state boost GDP in the short-run but do not boost employment. While the short-run GDP boost appears to be driven by funding shocks that occur during recessions, employment does not appear to rise even in this case. We also found that the short-run (and long-run) GDP effects of highway funding shocks are smaller for states whose GDP is growing slower than the median state. Overall, these results suggest that highway spending––at least the kind of highway spending typically done over the past twenty years––may not be well-suited to be an effective type of stimulus spending. On the other hand, we found that the highway funding shocks occurring during 2009, the year of the ARRA stimulus package as well as the trough of the Great Recession, had unusually large short-run impacts on GDP. A possible implication is that, on average, highway spending may not be especially effective at providing short-run stimulus, but that it can be more effective during times of very high economic slack and/or when monetary policy is at the zero lower bound.

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