Economic Consequences of Public Investment News Shocks

This paper explores the macroeconomic consequences of government investment in European Union countries from 2000 to 2020. To tackle the endogeneity of government investment, I constructs a new instrument for public investment shocks based on narratives for European Investment Bank (EIB) public loans. Using more than 6300 loans financing projects in 18 EU countries, I show that the loans allocated to public firms are a good instrument for public investment shocks. Using local projection, I find that these shocks increase output, consumption, and employment in the economy without crowding out private investment. The cumulative three-years public investment multiplier is higher for countries with: lower per capita GDP, lower debt, lower uncertainty, higher local autonomy, and higher government size. Using a medium-scale New Keynesian DSGE model, including financial friction and public capital, I show that the news of a possible government investment increases the expected profit of firms and weakens the credit constraint. As a result, firms can borrow more due to a better economic perspective, and the crowding-out effect disappears.