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Effects of monetary and fiscal policies on firm size distribution and economic growth

Author

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  • Zhijie Zheng

    (Beijing Normal University)

  • Ruiyang Hu

    (Shenzhen Finance Institute, The Chinese University of Hong Kong, Shenzhen (CUHK-Shenzhen))

Abstract

This study investigates the effects of monetary and fiscal policies on firm size distribution and economic growth in an endogenous growth framework featuring heterogeneous firms, financial constraints, and government spending on productive infrastructure development and non-productive public goods. Our analytical results indicate that higher interest rates and corporate income tax rates can enhance the innovation rate of incumbent firms by improving infrastructure. However, the impact on the innovation rate of entrant firms is ambiguous due to the additional countervailing effect of labor reallocation. Increases in the interest rate and the corporate income tax rate can potentially reduce (raise) the market share of large firms, if the percentage increase in the innovation rate of entrants is higher (lower) than that of incumbents. Numerical simulations using US data suggest that higher interest rates decrease the market share of large firms and promote economic growth. In addition, while the effect of the corporate income tax rate on the innovation rate of entrants follows an inverted-U shape, a heavier tax burden consistently diminishes the market share of small firms and benefits large incumbents.

Suggested Citation

  • Zhijie Zheng & Ruiyang Hu, 2025. "Effects of monetary and fiscal policies on firm size distribution and economic growth," Journal of Economics, Springer, vol. 146(3), pages 347-377, December.
    • Handle: RePEc:kap:jeczfn:v:146:y:2025:i:3:d:10.1007_s00712-025-00910-4
    DOI: 10.1007/s00712-025-00910-4
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    JEL classification:

    • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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