Dundee Discussion Papers in Economics 247: Subsidies as optimal fiscal stimuli

Hassan Molana, Catia Montagna, Chang Yee Kwan

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    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.
    Original languageEnglish
    PublisherUniversity of Dundee
    Number of pages17
    Publication statusPublished - Nov 2010

    Publication series

    NameDundee Discussion Papers in Economics
    PublisherUniversity of Dundee
    ISSN (Print)1473-236X


    • Fiscal policy
    • international trade
    • Monopolistic competition
    • Nash equilibrium
    • policy coordination
    • welfare


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