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Subsidies as Optimal Fiscal Stimuli

Hassan Molana, Catia Montagna and Chang Yee Kwan

No 2010-96, SIRE Discussion Papers from Scottish Institute for Research in Economics (SIRE)

Abstract: In the theoretical macroeconomics literature, fiscal policy is almost uniformly taken to mean taxing and spending by a ‘benevolent government’ that exploits the potential aggregate demand externalities inherent in the imperfectly competitive nature of goods markets. Whilst shown to raise aggregate output and employment, these policies crowd-out private consumption and hence typically reduce welfare. In this paper we consider the use of ‘tax-and-subsidise’ instead of ‘taxand- spend’ policies on account of their widespread use by governments, even in the recent recession, to stimulate economic activity. Within a static general equilibrium macro-model with imperfectly competitive good markets we examine the effect of wage and output subsidies and show that, for a small open economy, positive tax and subsidy rates exist which maximise welfare, rendering no intervention as a suboptimal state. We also show that, within a two-country setting, a Nash non-cooperative symmetric equilibrium with positive tax and subsidy rates exists, and that cooperation between trading partners in setting these rates is more expansionary and leads to an improvement upon the non-cooperative solution.

Keywords: fiscal policy; international trade; monopolistic competition; Nash equilibrium; policy coordination; welfare (search for similar items in EconPapers)
Date: 2010
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Journal Article: SUBSIDIES AS OPTIMAL FISCAL STIMULI (2012) Downloads
Working Paper: Subsidies as Optimal Fiscal Stimuli (2010) Downloads
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