Public investment and potential output

This discussion paper sets out how public investment is accounted for in our fiscal forecast, before exploring the key transmission mechanisms through which it can affect potential output. It then outlines our proposed approach to modelling the impact of public investment on potential output. We assess the time lags between public investment and its impact on UK productive capacity and the scale of the long-run effect. We use a calibrated model to simulate the impacts of a stylised unit shock to public investment of +1 per cent of GDP.  The impact of cuts to public investment can be estimated using the same tools and would be symmetric. In our initial, high-level, and partial equilibrium analysis, we find that a sustained 1 per cent of GDP increase in public investment could plausibly increase the level of potential output by just under ½ a percent after five years and around 2½ per cent in the long run (50 years). It then explores a set of further issues in assessing the effects of changes in a government’s public investment plans. It concludes by setting out a range of questions on which we would welcome feedback.