public infrastructure investment. Public investment in infrastructure<sup>9</sup> amounts to 2.8% of GDP made up of central government investment (0.6% of GDP) and decentralized government infrastructure outlays (2.2% of GDP). The model economy also matches the average level and composition of imports. Total imports amount to 18.5% of GDP. This is composed of import of consumption goods (3.7% of GDP), capital goods (6.1% of GDP) and intermediate goods (8.7% of GDP).

The structure of central government tax revenue is similar to the one observed in Colombia. Total tax revenue in the model amounts to 14.1% of GDP, which is very close to what is observed in the data. This percentage includes consumption taxes (7.4% of GDP), labor income taxes (0.6% of GDP) and capital income taxes (6.1% of GDP). The split in the income taxes between labor and capital income taxes is based on information from DIAN on tax withholding figures organized by type of taxpayer. The model’s gross debt-GDP ratio of the central government is set at 54%, which corresponds to the observed ratio by year-end 2003 (source: CONFIS). The net debt-GDP ratio of the rest of the public sector is set at 0% of GDP. This is roughly consistent with CONFIS data estimating the level of the combined public sector (‘non-financial public sector’) gross debt to be 68% of GDP and a combined net debt (excluding holdings of central government bonds in the portfolio of the rest of the public sector) to be close to 54% of GDP. The model’s external debt-GDP ratio is set at 50% of GDP (source: Banco de la República).

The interest rate charged to private and public borrowers is the sum of two components: •• an exogenously given world interest rate proxied by the U.S. interest rate ( r = 4%, see Prescott, 1986; Backus et al., 1994) and a borrowing premium measured by the JP Morgan’s Latin America Eurobond Index spread. The average spread for Colombia was 420 basis points over the last quarter of 2003 (z = 0.042) . The semi-elasticity of the borrowing spread with respect to the debt-GDP ratio is set at ε = 0.3 as a reasonable compromise.<sup>10</sup> An expression for β can be obtained from the first order conditions, evaluated at the steady state, relating interest and subjective discount rates:

> 9 The public sector invests in physical infrastructure 2.8% of GDP, which corresponds to the average level during the 1994-2002 period (includes investments in transport, energy, telecom and oil sectors). Because there is no data available to disentangle the contributions of the central government and the rest of the public sector to this number, public investment in infrastructure is split using NIPA’s contributions to gross public capital formation. The average contribution of the central government is 23% during the period 1994-2001. In consequence, under the benchmark policy stance the central government is estimated to invest 0.6% of GDP in infrastructure and the rest of the public sector invests the remaining 2.2% of GDP. 10 In empirical studies the debt variable is generally defined as total external debt and not as total public debt. Min (1998) estimates ε = 1 and Cantor and Packer (1996) find no significant relation between the debt-GDP ratio and yield spreads. Eichengreen and Mody (2000) estimate ε = 1.3 . Hilscher and Nosbusch (2004) define debt as total government external debt and from their point estimate it is possible to calculate ε = 0.02 , approximately.

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