Simple Analytics of the Government Investment Multiplier

TL;DR

This paper introduces a unified, simple analytical framework using a Markov chain approach to evaluate the effects of public infrastructure investment across different economic scenarios, including liquidity traps.

Contribution

It develops a general solution method that encompasses existing models and provides a unified analysis of public investment multipliers in various macroeconomic conditions.

Findings

Multipliers can diverge with the duration of liquidity traps.

The framework simplifies analysis of public investment effects.

It unifies different scenarios within a single modeling approach.

Abstract

What are the effects of investing in public infrastructure? We answer this question with a New Keynesian model. We recast the model as a Markov chain and develop a general solution method that nests existing ones inside/outside the zero lower bound as special cases. Our framework delivers a simple expression for the contribution of public infrastructure. We show that it provides a unified framework to study the effects of public investment in three scenarios: $(i)$ normal times $(ii)$ short-lived liquidity trap $(iii)$ long-lived liquidity trap. We find that calibrations commonly used lead to multipliers that diverge with the duration of the trap.