government investment and the european stability and growth...

Government Investment and the European Stability andGrowth Pact

Marco Bassetto1 Vadym Lepetyuk2

1Federal Reserve Bank of Chicago

2University of Minnesota

Marco Bassetto, Vadym Lepetyuk Govt investment and SGP 1 / 21

The SGP

A set of regulations that complement the Maastricht treaty.

Limits on deficit/GDP, debt/GDP (debt/GDP effectively notenforced).

Original version:

deficit/GDP < 3%, except in case of a severe recessiondeficit/GDP limit independent of type of spending: interest, publicconsumption, public investment


Should investment be excluded?

Many advocates of the “golden rule”

Identified as an important shortcoming of SGP (e.g. Blanchard andGiavazzi, 2004)

One element to take into account after 2005 reform

Quantitative importance? Bassetto with Sargent (2006): big numbersfor U.S. states, smaller for fed. govt.


Plan of the talk

The model

Data

Quantitative results


The model - People

Model essentially identical to Bassetto with Sargent (2006)

OLG, live up to N + 1 periods (years)

Prob of survival from age s to s + 1: θs

Constant pop. growth rate n

Constant fraction of pop. by age


The model - Goods, preferences, and technology

3 goods: private consumption, public consumption, public capital(depreciates at rate δ)

Preferences:

N+t∑s=t

βs−t

s−t−1∏j=0

θj

[cs−t,s + f (Gs) + v(Γs)]

Technology:Ct + Gt + γt ≤ y

γt : public investment

y given


The model - Government

Govt levies lump-sum taxes Tt , purchases public goods.

Budget constraint:

Bt = Gt + γt − Tt +1 + r

1 + nBt−1,

SGP pact:

Bt −Bt−1

1 + n≤ d + xγt

Key parameters of SGP: d , x


The model - Political process

Spending and taxes chosen by majority voting, subject to SGP

Will unanimously choose Tt so that deficit ceiling binds

Median voter exists


The model - Equilibrium

Competitive equilibrium in private markets (with annuities)

Political-economic equilibrium (forward-looking voting)


Efficient allocation

f ′(Gt) = 1, t = 0, . . .

v ′(Γt) = 1− β(1− δ), t = 0, . . .

Measure of deviations from efficiency: wedge (more robust thanalternatives)

τ =v ′(Γt)− v ′(Γ∗)

v ′(Γ∗)


Some results from theory

Gt = G ∗.

d does not matter for efficiency, only x does:

Tt = Gt +rBt−1

1 + n+ (1− x)γt − d

With Ricardian equivalence, Γt = Γ∗ and x does not matter. xmatters when:

1 Population grows fast;2 Mortality is high (if the old are in charge)3 Mobility is high (if the young are in charge)


Calibration

β = 0.96;

Depreciation rate:{δ = 0.06 general capital;δ = 0.03 major infrastructure;


Data

Baseline: Eurostat.

Robustness check: Eurobarometer survey


Summary data

Pop. growth Migration rate (%)(%) (baseline) (Eurobar.)

AUT 0.5 0.9 0.5FIN 0.5 0.2 1.0GER 0.3 0.8 0.5IRE 2.1 n/a 1.5ITA 0.4 0.1 0.6LUX 1.1 2.6 0.7NL 0.5 0.5 0.9

US federal 1.2 0.1Median state 1.0 2.1


Wedge for major infrastructure (%)

SGP 1997 Golden ruleAUT 24 -17BEL 16 -16GER 21 -16ITA 9 -14LUX 51 -25NL 19 -16SPA 24 -18

US federal 20 -18Median state 48 -24

Go to results for generic capital


Debt maturity

Bassetto with Sargent (2006): golden rule does very well

Here: not so well

Why?

States do not roll over debt, but repay over time

Tt = Gt +(r + α)Bt−1

1 + n+ (1− x)γt − d

SGP allows indefinite debt rollover (α = 0)


Gross vs. net investment

What if we exclude net investment from deficit?

Bt −Bt−1

1 + n≤ d + x

(γt − δ

Γt−1

1 + n

),

Equivalent to setting a schedule to repay debt.


Wedge for major infrastructure (%)

ExcludingSGP 1997 Gross Net

AUT 24 -17 0.9BEL 16 -16 0.7GER 21 -16 -0.1ITA 9 -14 0.9LUX 51 -25 3.4NL 19 -16 1.2SPA 24 -18 5.7

US federal 20 -18 5Median state 48 -24 3.1

Go to results for generic capital Go to robustness


Conclusions

Europe has low mobility, growth: close to Ricardian equivalence

If investment excluded, should be net


Wedge for generic capital (%)

SGP 1997 Gross NetAUT 16 -24 0.2BEL 11 -22 0.1GER 14 -23 -0.5ITA 6 -20 0.4LUX 35 -34 1.3NL 13 -22 0.5SPA 16 -25 3.4

US federal 14 -24 3.1Median state 33 -32 1.4

Back to infrascructure, gross Back to infrastructure, net


Eurostat vs. EurobarometerSGP 1997 major infr., wedge in %

Baseline EurobarometerAUT 24 17BEL 16 21FRA n/a 25GER 21 21IRE n/a 49ITA 9 20LUX 51 28NL 19 26SPA 24 31

Back to baseline


government investment and the european stability and growth...

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