Mind the Gap: Government Investment Announcement and Implementation

Abstract

This study develops a dynamic stochastic general equilibrium model calibrated to the US economy to investigate the effects of government investment on macroeconomic variables and social welfare. The analysis focuses on the role of the gap between the announced size and actual implementation. In general, government investment shocks bring positive results for output in the short- and long-run, although they may cause consumption crowding out in the short-run. However, anticipated government investment lowers the consumption crowding-out effect. Higher levels of implementation relative to the announced investment positively impact output and consumption in the medium- and long-run. The benefits to the economy are greater when the productivity of public capital is higher. Moreover, the study uncovers a trade-off between social welfare and the government multiplier: Full or over-implementation of public investment results in significant social welfare gains without compromising the benefits in terms of the government multiplier.