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

Cooke, D; Damjanovic, T.

Abstract

This paper studies firm entry with nancial frictions. We motivate our analysis by documenting that a fall in rm entry and a widening of the interest rate spread occur when there is a rise in idiosyncratic uncertainty. We then develop a model of rm entry and nancial frictions - with uctuations in the volatility of rm-level demand shocks - consistent with this empirical evidence. Finally, we study dividend and labor-income taxation. Financial frictions weaken the incentive to support rm entry, and in a calibrated version of our model, accounting for the increase in volatility observed during the 2007-09 recession, optimal scal policy raises (lowers) dividend (labor)-income taxes by up to 7 (1:5) percentage points.

Citation

Cooke, D., & Damjanovic, T. (2020). Optimal Fiscal Policy in a Model of Firm Entry and Financial Frictions. Review of Economic Dynamics, 35, 74-96. https://doi.org/10.1016/j.red.2019.05.001

• Journal Article Type: Article
• Acceptance Date: May 5, 2019
• Online Publication Date: May 10, 2019
• Publication Date: Jan 31, 2020
• Deposit Date: May 9, 2019
• Publicly Available Date: Nov 10, 2020
• Journal: Review of Economic Dynamics
• Print ISSN: 1094-2025
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 35
• Pages: 74-96
• DOI: https://doi.org/10.1016/j.red.2019.05.001
• Public URL: https://durham-repository.worktribe.com/output/1296669