Optimal Fiscal Policy when Public Capital is Productive: A Business Cycle Perspective

This paper develops a dynamic general-equilibrium model with productive public capital to help account for differences in the business cycle characteristics of public- versus private-sector expenditures in postwar U.S. data. A specification that allows for multiple stochastic shocks (to technology and depreciation rates) can reproduce a number of features describing the cyclical behavior of U.S. public investment and public consumption as well as other fiscal variables, such as average marginal tax rates and the government debt-to-output ratio. The model also delivers reasonable predictions for the behavior of private-sector aggregates. It is less successful, however, in capturing the large variability of public consumption expenditures in U.S. data, and it overpredicts the variability of the capital tax relative to the labor tax.