Market structure and fiscal policy effectiveness

In a monopolistic competition macromodel with endogenous market structure, the fiscal multiplier is shown to consist of two components. One component depicts the response of output to a fiscal expansion through the conventional channels that disregard the role of market imperfections and a second one captures the effect of both firms’ market power and the policy induced change in the market structure. The latter effect – which is missing from the existing studies – is shown to be quite crucial in raising the fiscal multiplier even above unity, and also in improving consumers’ welfare when the labour market is competitive.