Analysis of the Transmission Mechanism of Public Investments: The Case of the DSGE Model

Abstract

This paper attempts to assess the impact of public investment within the framework of a simple DSGE model calibrated on Russian data. To this end, three versions of the DSGE model were constructed. The first model, referred to as the baseline model, assumes efficient allocation of public investment. The second model considers inefficient use of public investment when it is not fully converted into capital. The third model examines crowding out of private investment by public investment. The primary focus of this paper is to analyze the effects of public investment shock on various components of the economy. Two distinct effects are identified with regard to investment. The first effect relates to a short-term increase in demand due to an increase in investment activity. The size of this effect is strongly influenced by the crowding-out phenomenon, in particular by the ability of the economy to absorb investment effectively. The second effect is a reduction in marginal costs in the medium to long run, which facilitates economic growth even at the expense of increased private investment. This effect depends primarily on the efficiency of transformation of public investment into capital. The study also analyzes the sensitivity of the results to parameterization, including the degree of economic openness. The findings of the study explain the transmission mechanism of public investment, including the factors affecting its efficiency. It is important to note that the main objective of the study was to investigate the transmission mechanism and its determinants, while the next stage of the research is expected to include a comprehensive assessment of the parameters using Russian data.