Causal Macroeconomic Effects of Public Investment

This paper estimates the causal impact of public investment on economic activity in European economies. While the literature generally finds that public investment multipliers exceed those of public consumption, the existing estimates vary widely, reflecting, among other factors, the challenges of identifying exogenous public investment shocks in the presence of anticipation and endogeneity. We address these challenges by using the European Commission’s public investment forecast errors as an instrument for realised public investment within an IV-LP framework. We construct a novel dataset covering 23 European countries over 2002–2023 and measure public investment forecast errors in real monetary terms rather than as differences between forecast and realised public-investment-to-GDP ratios, thereby avoiding variation arising mechanically from the GDP denominator. We estimate cumulative multipliers in a single step, allowing us to quantify their uncertainty directly. These multipliers relate the cumulative output response to the cumulative change in public investment, accounting for spending effects that persist be-yond the initial shock. The findings suggest that the cumulative multiplier of public investment reaches approximately 2.1 after five years, with most of the effect materialising within the first 2–3 years. The multiplier is state-dependent: it is significantly larger during recessions, when public debt is low, and when the existing stock of public capital is relatively low.

JEL codes: E22, E62, H54, C33, C26.
Keywords: public investment, investment multiplier, forecast errors, local projections, instru-mental variables.
 

The authors would like to thank Uldis Rutkaste, Mārtiņš Bitāns, Kārlis Vilerts, Joa˜o Jalles, Jose Alves, Johannes Fleck, Michael Charalambos, Marvin No¨ller, as well as participants in seminars at the Bank of Latvia, the Institute of Applied Mathematics at Riga Technical University, the 14th UECE Conference on Economic and Financial Adjust-ments, the 8th International Conference on European Economics and Politics, the 8th Baltic Economic Association Conference, and the 2026 WGPF Public Finance Workshop for their useful feedback and suggestions. The views expressed are those of the authors and not necessarily those of the Bank of Latvia nor the ESCB. Any remaining errors are the authors’ sole responsibility.