Fiscal Policy and Entrepreneurship
This paper reexamines the effect of expansionary fiscal policy on real GDP in the presence of entrepreneurship, which is defined as firms' activities to predict and adapt to changes in consumers' tastes. As government expenditure cannot reflect changes in consumers' tastes, it weakens the social role of the firms' ability to process local information for predicting the changes. Hence, government expenditure cannot perfectly substitute for private consumption. It is shown that expansionary fiscal policy can lower real GDP when idiosyncratic risk and the substitutability of goods are large, and when firms have a strong ability to predict changes in consumer tastes. In addition, this paper shows that expansionary fiscal policy discourages firms from investing in activities that aid prediction in the short run. However, expansionary fiscal policy does not influence investment in prediction ability in the long run.
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