DP9977 Demand expectations and the timing of stimulus policies
This paper proposes a simple macroeconomic model with staggered investment decisions. The expected return from investing depends on demand expectations, which are pinned down by fundamentals and history. Owing to an aggregate demand externality, investment subsidies can improve welfare in this economy. The model can be used to address questions concerning the timing of stimulus policies: should the government spend more on preventing the economy from falling into a recession or on rescuing the economy when productivity picks up? Results show the government should strike a balance between both objectives.