Political instability, public investment and macroeconomic performance

Abstract

This paper attempts to provide a framework to explain both the lower share of current spending in large fiscal adjustments and the potential expansionary effects of fiscal contractions. We distinguish between current spending and productivity enhancing public investments and analyze the potential determinants of the policy maker's choice for the composition of overall public spending. Using this framework, we also link the overall macroeconomic performance to the public spending decisions. Our results suggest that raising current spending at the expense of public investment is associated with less favourable performance in terms of not only inflation and output but also, interestingly, future 'current' spending.