Fiscal policy, monopolistic competition, and finite lives

This paper studies the short-run, transitional, and long-run output effects of permanent and temporary shocks in public consumption under various financing methods. To this end, a dynamic macroeconomic model for a closed economy is developed, which features a perfectly competitive final goods sector...

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Bibliographic Details
Published in:Journal of economic dynamics & control 2007, Vol.31 (1), p.325-359
Main Authors: Heijdra, Ben J., Ligthart, Jenny E.
Format: Article
Language:English
Subjects:
Consumption
Economic models
Economic shock
Fiscal policy
Labor supply
Labour supply
Love of variety
Macroeconomics
Monopolistic competition
Output multipliers
Overlapping generations
Studies
Temporary fiscal shocks
Yaari–Blanchard model
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Summary:This paper studies the short-run, transitional, and long-run output effects of permanent and temporary shocks in public consumption under various financing methods. To this end, a dynamic macroeconomic model for a closed economy is developed, which features a perfectly competitive final goods sector and a monopolistically competitive intermediate goods sector. Finitely lived households consume final goods, supply labor, and save part of their income. Amongst the findings for a permanent rise in public consumption are: (i) monopolistic competition increases the absolute value of the balanced-budget output multiplier; (ii) positive long-run output multipliers are obtained only if the generational turnover effect is dominated by the intertemporal labor supply effect; (iii) short-run output multipliers under lump-sum tax financing are smaller than long-run output multipliers if labor supply is elastic; and (iv) bond financing reduces the size of long-run output multipliers as compared to lump-sum tax financing and may give rise to non-monotonic adjustment paths if labor supply is sufficiently elastic and the speed of adjustment of lump-sum taxes is not too high. Temporary bond-financed fiscal shocks are shown to yield: (i) permanent effects on output; and (ii) negative long-run output multipliers.
ISSN:0165-1889
1879-1743
DOI:10.1016/j.jedc.2005.12.003