Innovation Dynamics and Fiscal Policy: Implications for Growth, Asset Prices, and Welfare

39 Pages Posted: 20 Oct 2016 Last revised: 2 Feb 2017

See all articles by Michael Donadelli

Michael Donadelli

University of Brescia

Patrick Grüning

Vilnius University - Faculty of Economics and Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: January 30, 2017

Abstract

We study the equilibrium implications of different fiscal policies on macroeconomic quantities, asset prices, and welfare by utilizing two endogenous growth models. The expanding variety model features only homogeneous innovations by entrants. The Schumpeterian growth model features heterogeneous innovations: "incremental" innovations by incumbents and "radical" innovations by entrants. The government finances its expenditure stream by labor income and corporate taxes and supplies subsidies to household's consumption, to final goods firm's capital investment, and to investments in research and development (R&D) by entrants and, if applicable, incumbents. Regardless of the innovation structure, an increase in consumption subsidies induces lower economic growth resulting in sizable welfare costs. Differently, higher R&D subsidies induce higher economic growth alongside a welfare loss in the homogeneous innovation model. However, in the heterogeneous innovation model subsidies to incumbents are growth-enhancing and welfare-depressing, whereas subsidies to entrants lead to lower growth but higher welfare. Only higher capital investment subsidies lead to jointly higher growth and welfare in both innovation models. Fiscal policies should therefore prioritize the allocation of resources to capital investment.

Keywords: Endogenous Growth, Asset Pricing, Government, Fiscal Policy, Heterogeneous Innovation

JEL Classification: E22, G12, H20, I30, O30

Suggested Citation

Donadelli, Michael and Grüning, Patrick, Innovation Dynamics and Fiscal Policy: Implications for Growth, Asset Prices, and Welfare (January 30, 2017). Available at SSRN: https://ssrn.com/abstract=2854895 or http://dx.doi.org/10.2139/ssrn.2854895

Michael Donadelli

University of Brescia ( email )

Piazza del Mercato, 15
25122 Brescia
Italy

Patrick Grüning (Contact Author)

Vilnius University - Faculty of Economics and Business Administration ( email )

Sauletekio al. 9 (II building)
Vilnius, LT-10222
Lithuania

HOME PAGE: http://www.evaf.vu.lt/en/

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