Investment Performance, Capital-Widening and Economic Policy

Abstract

Fixed investment as a share of GDP has declined over a long period in many G10 countries. The aim of the paper is to provide a theoretical framework for explaining this. The model emphasises the negative effect on investment of uncertainty about the effects of a policy response to an output gap. When government contracts demand to close an output gap that is the result of an initial decline in fixed investment, it tends to exert a cumulative depressive effect on capacity and growth. Since this involves a dynamic process the mechanisms at work are illustrated through a theoretical simulation approach.