Fiscal policy and public capital in interdependent economies

A two-country model is presented that has the following features: public and private capital accumulation, government debt and current account dynamics, differential saving propensities for profits and wages, imperfectly substitutable domestic and foreign commodities, a floating exchange rate, wage rigidities and flexible prices. Public capital enters into the aggregate production function. Congestion is taken into account by adjusting infrastructure for aggregate use of private factors. Numerical methods are used to trace the effects of higher public investment. Raising government investment proves to be advantageous for both regions. However, sensitivity analysis demonstrates that the long-run results in particular depend on the production-elasticity of congestion-corrected public capital.