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Inequality, imperfect competition and their effect on fiscal policy, output and welfare

Balamatsias, Pavlos (2017): Inequality, imperfect competition and their effect on fiscal policy, output and welfare.

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Abstract

We use a New Keynesian model with imperfectly competitive goods markets and income inequality and study their impact on fiscal multipliers, output and welfare. Results show that imperfect competition has a positive effect on the government spending multiplier and a negative effect on tax multipliers. In addition, imperfect competition positively affects the balanced budget multiplier. Inequality positively affects the government spending multiplier but negatively affects the tax and balanced budget multipliers when poor workers are taxed, while the opposite is true when wealthy workers are taxed. Looking at the welfare effects of imperfect competition, we find that it positively affects the net welfare gains of both income groups as well as social welfare. In addition, greater numbers of poor workers reduce net welfare gains and social welfare when they are the ones taxed while the opposite is true when wealthy workers are taxed. Changes in workers’ MPCs have an ambiguous effect on net welfare gains and social welfare when poor workers are taxed but a positive effect when wealthy workers are taxed. Therefore, our model proves that under imperfect competition and income inequality the maximum net increase in expenditure, output and social welfare comes when the government increases government spending and taxes wealthy workers.

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