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OPINION August 20, 2020

Addressing Crisis Through Infrastructure

Fiscal policy plays a major role in counteracting recession when monetary policy hits the zero-bound and the worst-hit sectors are not interest-sensitive. Infrastructure stimulus generally creates larger economic benefits, because it not only puts people to work, but also creates durable assets that can help boost long-term growth. Infrastructure investments formed a significant component of stimulus programs following the 2008 financial crisis (see figure). This type of investment is frequently cited as a necessary element of COVID-19 recovery packages.


Much discussion on infrastructure stimulus centers on the size of the "multiplier," that is whether government spending crowds in or out private sector investment and consumption. The efficacy of infrastructure investments depends crucially on where and how these programs are implemented.

Macroeconomic conditions determine a stimulus package’s effectiveness. Infrastructure stimulus is more likely to succeed in a more closed economy, with a fixed exchange rate regime. It requires loose monetary policy, so that fiscal expansion is not offset by a reduction in net exports, exchange rate appreciation or monetary tightening.

Initial fiscal conditions matter. Countries can respond to crisis more aggressively if enough fiscal space exists before the upheaval. When initial conditions are healthy, fiscal expansion is less likely to endanger debt sustainability and hamper growth in the long term. When taxes are distortionary, debt-financed spending will be more effective in boosting employment and output than spending that is paid with higher current tax (see table).