Short-Term Impact of Public Capital

Abstract: The literature on the macroeconomic impact of public capital investment suggests that public capital enhances growth and facilitates private capital formation. Standard vector autoregressive (VAR) models have become the most popular empirical method to examine the effects of public investment, because this method requires few assumptions about how public capital interacts with the economy. However, previous studies did not employ large information sets, or control for the possibility of forward looking economic agents. To test the robustness of previous findings, this study augments the VAR framework with factor analysis of large data sets and includes proxies for economic foresight about future public investment. This study finds that the conventional VAR specification excludes relevant information potentially generating an upward bias in the short-term affect public capital investments have on growth. The response of private capital formation to shocks in public capital is found to be aligned with previous studies. Finally, the results of this study find no strong indication that expectations aboutfuture public investments affect private sector activity.