Capital Idea

• Author: Selim Elekdag and Dirk Muir
• Position: a Deputy Division Chief in the IMF's Monetary and Capital Markets Department and is an Economist in the IMF'€™s Research Department.

The economic recovery in the euro area is slow and tentative, and growth in even the strongest economy, Germany, seems to have lost some momentum in recent years. Moreover, estimates of German growth potential are low—and could go lower because of a rapidly aging population.

But there is a way to mitigate growth problems in Germany and, by extension, throughout the euro area. Increased German public investment in infrastructure, such as highways and bridges, would not only stimulate near-term domestic demand, but would also increase productivity and raise domestic output over the longer run and generate beneficial spillovers across the rest of the euro area.

Although Germany’s public infrastructure is not widely seen as deficient, it has in fact been neglected for some time, especially in the transportation area, where pressing needs, such as aging roads, have been clearly identified. Germany’s public investment in infrastructure is in the bottom quarter of the 34 advanced and emerging market economies of the Organisation for Economic Co-operation and Development. In fact, net public investment has been negligible since 2003: the average ratio of net government investment to net domestic product over the past decade is –0.1 percent, which is associated with deterioration in the public capital stock (see Chart 1). Greater infrastructure investment would likely significantly expand German potential output—that is, the largest GDP an economy can produce sustainably. For example, better infrastructure would ease the movement of goods used and produced by firms.

Spillovers from Germany

We used the IMF’s Global Integrated Monetary and Fiscal model (see box) to try to quantify the domestic effects and spillovers to other countries that would accompany increased German infrastructure investment (Elekdag and Muir, 2014). Our adaptation of the model combines four broad features:

● households that optimize consumption and saving, given their planning horizons;

● productive public stock of infrastructure;

● clear role for monetary policy; and

● multicountry framework, under which the world is grouped into six regions: Germany; Greece, Ireland, Italy, Portugal, and Spain (the Euro Five), which until recently had high external funding costs; the remaining euro area economies; emerging Asia; the United States; and the rest of the world.

A look at the model

The Global Integrated Monetary and Fiscal model (GIMF) is widely used at the IMF as a framework for analyzing the short- and long-term effects of fiscal...