Can an Increase of Infrastructure Spending Contribute to Higher Potential Output in the Medium and Longer Term?

Abstract

This discussion on recent economic literature concerns some issues on potential output and related policy implications. It is not clear to what extent potential output growth has been affected by the recent crisis. Then the actual stabilization policies —based on the existence of output gaps and public debt sustainability—might not be appropriate to mitigate effectively cyclical fluctuations and to stimulate economic growth. The recent empirical evidence on the determinants of potential output— i.e. the origin of cyclical fluctua tions—leads to a higher uncertainty on potential output measurement. Moreover the existing methods to estimate potential output present some weaknesses reducing reliability of the estimation results. Focusing on European case, the measure of potential output is considered as an useful guidance for policy. In particular, Stability and Growth Pact and Treaty on Stability, Coordination and Governance in the Economic and Monetary Union refer to the concepts of potential output, output gap and structural budget balance. Recently academics and some policy makers have criticized these measures and the related austerity policy because they worsened the economic situation. According to recent theoretical and empirical contributions it is important to rethink at the role of fiscal policy, focusing on fiscal stimulus and in particular on additional infrastructure spending because it can positively affect GDP as well as potential output. A part of this literature discusses extensively how public capital affects the economy. Under certain conditions such as a good institutional framework and sound projects, a higher spending on public infrastructure has a high economic impact.