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The role of government investments during crisis
submited on 10.11.2008 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
submited on 10.11.2008 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
Expansionary policy regarding public investments is planned by most of the governments, including the Bulgarian, as it was announced with the presentation of the government budget for 2009.
The supporters of public investments as anticrisis measure state that it helps avoiding two main dangers – steady deflation and recession.
Deflation is a threat due to several reasons. When there is deflation the nominal interest rates are usually close to zero. Thus it is possible for the economy to fall into liquidity trap – situation, when central bankers cannot stimulate economic activity via traditional monetary instruments. Deflation makes debt payments more difficult, because it increases real interest rates on credit. What is more, deflation leads to lower nominal income for producers, and therefore to smaller corporate profits, reducing the labor force and further unemployment growth.
Although inflationary dynamics is moderating in recent months, the probability of having steady consumer price deflation is relatively small.
The main argument for more public investments is actually the necessity of maintaining positive economic growth. It all comes down to two hypotheses regarding the Bulgarian economy. The first is that the local economy is at the moment working below its potential. In this case instead of increasing public investment more important are reforms, aiming at stimulating economic activity, improving the business environment, mobilizing the available labor resources. Despite the positive developments on the labor market in recent years, the employment rate remained relatively low compared to other EU countries.
The second hypothesis, supported mainly by foreign analysts, is that the economy is temporarily overheating. This condition is defined as overheating.
Even if we do not entirely accept the thesis that local economy is overheating, there are obviously sectors, which will contract, irrespective of whether it will happen due to unfavorable impact of the global conditions, the partial ceasing of the EU subsidies, or other (internal) factors.
Public investments in this case could provide higher employment, but impede the contraction of non-profitable activities and slow down the expansion of the more productive sectors. In other words, government investments impede the reallocation of resources from one sector to the other, which makes the economy less flexible versus the emergence of different internal and external shocks.
The main argument versus the excessive expansion of public investments is that they represent redistribution of resources via the budget mechanism, without changing the behavior of economic agents and without stimulating economic activity. The effect of public investments is usually short-term and does not improve the long-term perspective before the economy. After all government investments cannot substitute for private capital formation as driver of the economic growth.
The supporters of public investments as anticrisis measure state that it helps avoiding two main dangers – steady deflation and recession.
Deflation is a threat due to several reasons. When there is deflation the nominal interest rates are usually close to zero. Thus it is possible for the economy to fall into liquidity trap – situation, when central bankers cannot stimulate economic activity via traditional monetary instruments. Deflation makes debt payments more difficult, because it increases real interest rates on credit. What is more, deflation leads to lower nominal income for producers, and therefore to smaller corporate profits, reducing the labor force and further unemployment growth.
Although inflationary dynamics is moderating in recent months, the probability of having steady consumer price deflation is relatively small.
The main argument for more public investments is actually the necessity of maintaining positive economic growth. It all comes down to two hypotheses regarding the Bulgarian economy. The first is that the local economy is at the moment working below its potential. In this case instead of increasing public investment more important are reforms, aiming at stimulating economic activity, improving the business environment, mobilizing the available labor resources. Despite the positive developments on the labor market in recent years, the employment rate remained relatively low compared to other EU countries.
The second hypothesis, supported mainly by foreign analysts, is that the economy is temporarily overheating. This condition is defined as overheating.
Even if we do not entirely accept the thesis that local economy is overheating, there are obviously sectors, which will contract, irrespective of whether it will happen due to unfavorable impact of the global conditions, the partial ceasing of the EU subsidies, or other (internal) factors.
Public investments in this case could provide higher employment, but impede the contraction of non-profitable activities and slow down the expansion of the more productive sectors. In other words, government investments impede the reallocation of resources from one sector to the other, which makes the economy less flexible versus the emergence of different internal and external shocks.
The main argument versus the excessive expansion of public investments is that they represent redistribution of resources via the budget mechanism, without changing the behavior of economic agents and without stimulating economic activity. The effect of public investments is usually short-term and does not improve the long-term perspective before the economy. After all government investments cannot substitute for private capital formation as driver of the economic growth.
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