Public Investment as a Source of Capacity-Creating Autonomous Demand: Implications for Growth and Stability

Abstract

ABSTRACT Recent empirical research has highlighted the role played by public investment in stimulating economic activity, while addressing a variety of systemic challenges such as climate change and supply chain resilience. However, theoretical considerations regarding the capacity-building effect of public capital formation have been often overlooked in the demand-led growth literature. The paper addresses this gap by introducing a public investment component within a supermultiplier model, treating government investment and consumption spending as two separate components of autonomous demand, growing at different rates over the long run. The model is proven to be stable as long as the non-capacity-creating component of demand grows faster than public investment. Even though the latter does not have long-term growth effects in the steady state, it does affect economic activity during the traverse. The model is then calibrated and simulated, showing that movements between steady-state positions are extremely long-lasting, thus reinforcing the idea that supermultiplier models are better suited to describe out-of-equilibrium dynamics, while pointing out the potential role of public investment in shaping macroeconomic outcomes in the short, medium, and long run.