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Optimal Fiscal Policy in a Model of Firm Entry with Financial Frictions

Author

Listed:
  • Dudley Cooke

    (University of Exeter)

  • Tatiana Damjanovic

    (Durham University)

Abstract

This paper studies firm entry with financial frictions. We motivate our analysis by documenting that a fall in firm entry and a widening of the interest rate spread occur when there is a rise in idiosyncratic uncertainty. We then develop a model of firm entry and financial frictions – with fluctuations in the volatility of firm-level demand shocks – consistent with this empirical evidence. Finally, we study dividend and labor-income taxation. Financial frictions weaken the incentive to support firm entry, and in a calibrated version of our model, accounting for the increase in volatility observed during the 2007-09 recession, optimal fiscal policy raises (lowers) dividend (labor)-income taxes by up to 7 (1.5) percentage points. (Copyright: Elsevier)

Suggested Citation

  • Dudley Cooke & Tatiana Damjanovic, 2020. "Optimal Fiscal Policy in a Model of Firm Entry with Financial Frictions," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 35, pages 74-96, January.
  • Handle: RePEc:red:issued:18-243
    DOI: 10.1016/j.red.2019.05.001
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    More about this item

    Keywords

    Idiosyncratic uncertainty; Financial frictions; Firm entry; Optimal fiscal policy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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