Congestion and Fiscal Policy in a Two-Sector Economy with Public Capital: A Quantitative Assessment

Abstract

This paper analyzes the role of public capital when the services it yields is subject to two forms of congestion, which we characterize as relative and aggregate. We employ a two-sector growth model in which there are conventional profit-maximizing private firms, together with "public firms", whose objective is to produce a specified quantity of government investment goods --- determined by government policy --- at minimum cost. We characterize the equilibrium dynamics, and analyze two forms of fiscal disturbances --- an increase in public investment, and a decrease in the tax on capital income --- by simulating a calibrated economy. We contrast the effects of these two types of congestion on both the existing steady-state equilibrium, as well as for the effectiveness of fiscal policy.