Citation

Discussion Paper Details

Please find the details for DP10674 in an easy to copy and paste format below:

Full Details

Title: Optimal Fiscal Policy with Endogenous Product Variety

Author(s): Sanjay K. Chugh and Fabio Ghironi

Publication Date: June 2015

Keyword(s): Endogenous product variety, Optimal taxation, Producer entry, Wedge smoothing and Zero intertemporal distortions

Programme Area(s): Macroeconomics and Growth, Monetary Economics and Fluctuations and Public Economics

Abstract: We study Ramsey-optimal fiscal policy in an economy in which product creation is the result of forward-looking investment decisions by firms. There are two main results. First, depending on the particular form of variety aggregation, firms' dividend payments may be either subsidized or taxed in the long run. This policy balances monopoly incentives for product creation with the welfare benefit of product variety. In the most empirically relevant form of variety aggregation, socially efficient outcomes entail a substantial tax on dividend income, removing the incentive for over-accumulation of capital, which takes the form of the stock of products. Similar intuitions determine the optimal setting of long-run producer entry subsidies. Second, optimal policy induces dramatically smaller, but efficient, fluctuations of both capital and labor markets than in a calibrated exogenous policy. Decentralization requires zero intertemporal distortions and constant static distortions over the cycle. The results relate to Ramsey theory, which we show by developing welfare-relevant concepts of efficiency that take into account product creation. The results on optimal entry subsidies provide guidance for the study of product market reforms in dynamic macro models.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10674

Bibliographic Reference

Chugh, S and Ghironi, F. 2015. 'Optimal Fiscal Policy with Endogenous Product Variety'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10674