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Optimal Fiscal Policy with Endogenous Product Variety

  • Fabio Ghironi

    ()

    (Boston College)

  • Sanjay K. Chugh

    (University of Maryland)

We study Ramsey-optimal fiscal policy in an economy in which product varieties are the result of forward-looking investment decisions by firms. There are two main results. First, depending on the particular form of variety aggregation in preferences, firms' dividend payments may be either subsidized or taxed in the long run. This policy balances monopoly incentives for product creation with consumers' welfare benefit of product variety. In the most empirically relevant form of variety aggregation, socially efficient outcomes entail a substantial tax on dividend income, removing the incentive for over-accumulation of capital, which takes the form of variety. Second, optimal policy induces dramatically smaller, but efficient, fluctuations of both capital and labor markets than in a calibrated exogenous policy. Decentralization requires zero intertemporal distortions and constant static distortions over the cycle. The results relate to Ramsey theory, which we show by developing welfare-relevant concepts of efficiency that take into account product creation.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 775.

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Date of creation: 11 Aug 2011
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Handle: RePEc:boc:bocoec:775
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