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.
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.
Original language | English |
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Publisher | University of Dundee |
Number of pages | 17 |
Publication status | Published - Nov 2010 |
Publication series
Name | Dundee Discussion Papers in Economics |
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Publisher | University of Dundee |
No. | 247 |
ISSN (Print) | 1473-236X |
Keywords
- Fiscal policy
- international trade
- Monopolistic competition
- Nash equilibrium
- policy coordination
- welfare