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Abstract

One strand of the literature on endogenous growth concerns models in which public infrastructure affects the private production process. A puzzle in this literature is that observed public investment-to-output ratios for developed economies tend to fall short of theoretical model-based optimal ratios. We reexamine the optimal choice of public investment in a more general and plausible framework, which allows for a gradual transition between diferent steady states, a lower depreciation rate for public capital than for private capital, an elasticity of intertemporal substitution that differs from unity and the need to finance a non-trivial share of public services in output in each period. Given other fundamentals in the economy, we show that the optimal public investment-to-output ratio is smaller for low-growth economies, for economies populated by consumers with low preferences for substituting consumption intertem- porally and when public capital is durable. Moreover, for a calibrated economy, we show that a combination of these factors solves the public investment puzzle.