FISCAL POLICY IN A GROWING ECONOMY WITH PUBLIC CAPITAL

Abstract

Public capital subject to congestion is introduced into an endogenousgrowth model and the transitional dynamic paths under alternativefiscal policies are characterized. Several new insights are obtainedfrom this more general framework. During the transition, the twocapital stocks always approach their common equilibrium growth ratefrom opposite directions. Government policy induces the more volatileresponse in the capital stock upon which it impinges most directly:private capital in the case of a tax, public capital in the case ofexpenditure. Finally, we characterize a time-varying income tax thatenables the decentralized economy to replicate both the first-besttransitional dynamics and steady-state equilibrium of a centrallyplanned economy. The steady-state component corrects forexternalities that arise when government expenditure deviates fromits social optimum, and the effects of congestion. The transitionalcomponent corrects for myopic behavior by the representative agentalong the adjustment path.