Optimal Fiscal Policy with Endogenous Product Variety
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.
We thank Roc Armenter, Marco Bassetto, Susanto Basu, Florin Bilbiie, Jeffrey Campbell, Ippei Fujiwara, Andre Kurmann, Marc Melitz, and Henning Weber for helpful discussions, as well as participants in presentations at the Federal Reserve Bank of Boston, the Federal Reserve Bank of Chicago, Bilkent University, the IMF, the University of Zurich, the 2010 SED Annual Meeting, and the 2010 EEA Annual Conference. The views expressed in this paper are those of the authors and do not reflect those of the National Bureau of Economic Research, the Federal Reserve Bank of Boston, or Federal Reserve policy. Work on this paper was done while we held Visiting Scholar appointments at the Federal Reserve Bank of Boston, which we thank for hospitality and support. Ghironi also gratefully acknowledges support from the National Science Foundation through a grant to the NBER.