Public debt affects private investments

An investment program for crisis management

An intense debate has broken out in the USA about the size and impact of fiscal policy stimuli. The Biden administration has announced a package of around US $ 1.9 trillion, in addition to the package of US $ 900 billion agreed at the end of 2020, to cushion the consequences of the corona crisis. Larry Summers and Oliver Blanchard fear that this massive increase in spending could increase inflation. The expenditure program adopted is four times larger than that of the financial crisis and around three to five times as large as the current output gap. Paul Krugman, on the other hand, argues that in a health crisis, all means should first be taken to end it. In addition, the connection between unemployment and inflation would be structurally weaker - a fiscal stimulus that closes or even overcompensates the output gap would not lead to massive inflation.1 In the EU, on the other hand, the output gap is larger, but the fiscal stimulus is significantly smaller than in the USA. It is clear that the corona crisis is causing massive economic damage worldwide. According to conventional estimates, the output gap in Germany in 2020 was around -5.5% or a good 180 billion euros (joint forecast, 2020). In 2021 it should still be up to -4% or 130 billion euros. Most economists assume that the pandemic can be overcome in the course of the year - but this does not seem certain. It is too unclear how successful the global vaccination campaigns will be, whether mutants of the coronavirus will lead to new waves of infections and what damage the pandemic will cause in the corporate landscape or on the labor markets.

Public budgets do not currently have to fear that the debt or interest burden will lead to problems in the short term. On the contrary: the Federal Finance Minister can currently earn money by taking out loans. The interest rates for German securities are negative and are unlikely to rise anytime soon. In such a situation, it makes sense to spend too much rather than too little money in order to combat the crisis and its economic consequences. In addition, regardless of the current crisis, there is a considerable need for public investment in Germany. Various calculations from times before the corona pandemic show that between 300 billion and 450 billion euros will be needed to maintain and expand the infrastructure in Germany by 2030 (Bardt et al., 2019; Krebs and Scheffel, 2018; Barišić , Krebs and Scheffel, 2018; Fratzscher, 2015). It is true that public investment budgets have been increased in recent years, and the economic stimulus program from summer 2020 also includes corresponding additional expenditure. However, the size mentioned here is not yet included in the budget, so there is still a considerable gap (Belitz et al., 2020a) (see Table 1). This need for investment is unlikely to have decreased during the crisis. There is even a lot to suggest that now is a good time for a comprehensive modernization program that will stabilize economic development, increase growth potential and make the business location competitive for the challenges ahead (Belitz et al., 2020b).

Table 1
Investment needs and expenditures until 2030
 educationHousing constructionDigitizationClimate and TransportHealthvolumea
Investment needsb10050601200330
- Actions by the grand coalitionc1731821059
= Investment requirement minus resolutions834742990271
+ Health sector    1010
Need for investment before stimulus package8347429910281
- Economic stimulus package 2020d5016301061
Future packagee2 1630 48
All-day schools and daycare centers3    3
Health package    1010
open investment needsf784726690220

a Volume is calculated as the total requirement until 2030.

b Investment requirement according to Krebs and Scheffel (2017) extrapolated to 2030.

c Consideration of the measures from the coalition agreement for different durations in each case: Digital Pact School until 2024, broadband expansion until 2025, Structural Strengthening Act: coal regions until 2038, expansion of the rail network until 2030, funds to promote AI until 2025, municipal investment promotion law until 2022, EKF expenses (excluding rail ) until 2023.

d Investment and consumption measures of the economic stimulus program in the areas of education, housing construction, digitization, climate protection, public transport and municipal infrastructure.

e Investing and consuming measures in the areas of education, housing construction, digitization, climate protection, public transport and communal infrastructure.

f without additional requirements in connection with the permanent effects of the COVID-19 pandemic.

Source: Own compilation and calculations.

Crowding-in or -out through public investment?

An important function of public investments is to enable private investments, which are especially essential for the long-term transformation of the economy - in terms of climate protection, digitization and innovation. In principle, an increase in public investment can be accompanied by various macroeconomic effects, some of which have opposing effects. First, from a purely technical point of view, additional public spending induces an increase in gross domestic product (GDP) by the same amount. In addition, the short-term demand for private investments, consumption or imports is influenced (Abiad, Furceri and Topalova, 2016). Finally, public investments increase the capital stock and thus the production potential (Krebs and Scheffel, 2017; Ramey, 2020). This can have opposing effects that either stimulate (crowding-in) or suppress (crowding-out) private consumption and investment demand.

Crowding-in means pushing private demand through government investments. One reason for this is that there is increased demand for private goods through government investments and that these can be produced and provided more efficiently. For example, a state-financed expansion of the road network simplifies and accelerates the transport and trade of goods and services. Private companies therefore expect efficiency gains in production processes and higher profits, so that there are private-sector incentives for increased investment activity. Companies that can plan reliably with these future productivity gains will invest in the present. If these productivity gains are uncertain because, for example, the state orients its investment activities according to the cash situation, companies will reduce their own investment activities accordingly. The increase in public investment consequently leads in the theoretical context to an increase in the marginal productivity of private capital and an effective increase in the demand for private goods. With the crowding-out effect, public investments crowd out private-sector demand. In the literature, crowding-out effects are mostly derived from the fact that the state issues new government bonds to finance public investments. The consequence of the increased demand for credit is higher interest rates and thus rising capital costs. This, in turn, worsens the financing conditions of companies, which is why investments could be postponed or even be completely absent. In phases of persistently low interest rates, however, this channel is likely to be significantly weakened. But when public investment increases, the state also demands labor, which it consequently potentially deprives private companies. Against the background of demographic labor shortages that are already emerging, this is likely to become an increasingly important factor. In addition, the state can also raise the general price level through its additional demand, which can lower corporate profits and household incomes in real terms.

Investing in crises with high returns

Which effect prevails under which conditions is an empirical question that was investigated in a current study on the basis of a large number of estimation models (Belitz et al., 2020a) .2 The analyzes focus on different types of investment, time periods and industry differences. On the one hand, investments are made according to the narrow (VGR) delimitation, i. H. Construction, equipment and other investments are taken into account. On the other hand, investments in a broader sense are also recorded, i.e. H. also human potential investments (Dullien et al., 2020), which are measured in the study on the basis of expenditures in the areas of education, upbringing and health, which from a purely national accounts arithmetic perspective are assigned to government consumption. In addition, the effects are also examined with regard to different economic conditions, such as the economic situation, the current interest rate policy or economic uncertainty. For example, the effects can have a different effect in an economic overutilization than in a phase of underutilization or a recession. It turns out that public investments increase private investments on average across all models, maturities, types of investment and economic conditions. Public investments amounting to one euro lead to additional private investment activity of around 1.50 euros (see Figure 1). The GDP is growing at a similar rate.

illustration 1
Average crowding-in effect of public investments in the short and medium term

* on average over all months.

Source: Belitz et al. (2020a).

For some types of investment, such as B. R&D and human potential investments as well as in some cases also construction investments show a productivity effect which only leads to rising private investments in the medium term and which is particularly strong when the need for investment is high. A short-term, economically stimulating effect emanates from public construction and equipment investments on private construction investments. Because public construction and equipment investments ensure that private companies invest in equipment, among other things, to be able to carry out public construction contracts. However, these short-term effects disappear over time. In the longer term, however, some may want to benefit directly from the state infrastructure themselves and relocate or relocate. In addition, the relevance of economic conditions becomes apparent (see Figure 2). The crowding-in effect is positive in the vast majority of cases. It is particularly high in phases of economic underutilization. This suggests that public investments have great positive effects on overall economic demand in times when capacities are underutilized. Similar high crowding-in effects can also be demonstrated for periods in which the interest rate level is low. Conversely, the crowding-out effect predominates in phases of high interest rates. Economic uncertainty is also a situation in which public investment has a more stabilizing effect and thus stimulates private investment more than in safe times. In the current environment of the Corona crisis (recession, low interest rates, high uncertainty), public investments should therefore have significantly higher stabilization and growth effects than in phases of normal capacity utilization.

Figure 2
State-dependent crowding-in effect of public investments

Source: Belitz et al. (2020a).

Investment and growth program for Germany

The results suggest that in the current economic climate, an investment program would pay off twice. The economy is underutilized, uncertainty about future developments is high and interest rates are extremely low. At the same time, there is consensus on the need for extensive state investments for decarbonization, digitization, research and development, education, but also the built infrastructure. In June 2020, the federal government also envisages a “future package” with public investments and investment grants in these areas amounting to around 43 billion euros by 2024. According to the model estimates, 1 euro of this public expenditure could add around 1.60 euros to additional GDP by 2024 (see Figure 3). As a result, real GDP would be around 0.4% higher on an annual average through 2024 than without the program. Particularly in the low interest rate environment, as a result of which the financing costs for issuing government bonds are eliminated or can even become real financing profits, the additional growth should also make a noticeable contribution to the medium-term reduction of public debt.

Figure 3
Private investment and GDP as a result of public investment (gross fixed capital formation, investment grants, human potential expenditure) of the economic stimulus plan of July 2020

Source: Belitz et al. (2020a).

But even if the federal government has been promoting the modernization of the economy with various investment measures totaling around 110 billion euros since 2018, there will still be a public investment requirement of around 220 billion euros until 2030. The need continues to be great, particularly in the areas of education, climate protection and housing, as well as in the area of ​​infrastructure at the municipal level. It also makes sense to set appropriate priorities in the budgets of the federal, state and local governments, because this would partially offset the demographically induced losses in potential growth. With the increase in production potential, public and private capacities are expanded and production processes become more efficient, e.g. B. through digitized schools and public administrations or better childcare. Short- and medium-term demand bottlenecks, which could lead to rising prices due to the effective fiscal impulse, can be alleviated by the fact that a spending program is more long-term oriented towards investment needs and the modernization of the economy and thus not just one-off private demand or only a few Years is stimulated, but also the economic production capacities are permanently increased. This means that, in the long term, there will be no trade-off between a reduction in the national debt ratio and higher public spending on investments if these investments increase potential growth, thereby increasing tax revenues and relieving the burden on social security systems. Germany currently has a great need for such investments. This is a central result of the available studies, which is of great importance for the current economic policy debate in Germany.

  • 1https: //
  • 2 Among other things, structural VAR models, a proxy VAR with a narrative investment time series from the financial reports from 1970 to 2019, local projection estimates including forecast errors in the joint forecast, and a Bayesian estimated Fiscal DSGE model for Germany are used. The estimation results are also validated by various robustness tests.


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