Cover of EconPol Working Paper 28

Balanced-Budget Fiscal Stimuli of Investment and Welfare Value

Cesare Dosi, Michele Moretto, Roberto Tamborini

Is a fiscal stimulus of investment a viable complement to, or substitute for, monetary policy? The authors of this working paper show that, under a balanced-budget stimulus, investment acceleration may come at the expense of decreased total welfare and that where uncertainty is higher about private returns a net efficiency loss is more likely. However, the risk of such negative outcome strongly declines when the government spending is balanced by taxing both private and public returns on investment.

Abstract

Is a fiscal stimulus of investment a viable complement to, or substitute for, monetary policy? We address this issue by means of real option valuation of a private investment which generates private as well as public benefits. A surge in uncertainty about private profitability delays investment to an extent that may not be offset by monetary policy (conventional or not). Turning to fiscal policy, we examine the welfare effects of different policy schemes: (i) a simple subsidy on investment, (ii) a balanced-budget stimulus where the subsidy is covered by profit taxation, and (iii) by taxing public benefits as well. We show that, under a balanced-budget stimulus, investment acceleration may come at the expense of decreased total (private and public) welfare and that the higher is uncertainty about private returns, the more likely is a net efficiency loss. However, the risk of such negative outcome strongly declines when the government spending is balanced by taxing both private and public returns on investment.

Citation

Cesare Dosi, Michele Moretto and Roberto Tamborini: Balanced-Budget Fiscal Stimuli of Investment and Welfare Value, EconPol Working Paper 28, June 2019.