Optimal Fiscal Policy in a Model of Firm Entry with Financial Frictions

Dudley Cooke () and Tatiana Damjanovic ()

Review of Economic Dynamics, 2020, vol. 35, 74-96

Abstract: This paper studies firm entry with financial frictions. We motivate our analysis by documenting that a fall in firm entry and a widening of the interest rate spread occur when there is a rise in idiosyncratic uncertainty. We then develop a model of firm entry and financial frictions – with fluctuations in the volatility of firm-level demand shocks – consistent with this empirical evidence. Finally, we study dividend and labor-income taxation. Financial frictions weaken the incentive to support firm entry, and in a calibrated version of our model, accounting for the increase in volatility observed during the 2007-09 recession, optimal fiscal policy raises (lowers) dividend (labor)-income taxes by up to 7 (1.5) percentage points. (Copyright: Elsevier)

Keywords: Idiosyncratic uncertainty; Financial frictions; Firm entry; Optimal fiscal policy (search for similar items in EconPapers)
JEL-codes: E32 E44 E62 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.red.2019.05.001

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