Fiscal Stimulus in a Business Cycle Model with Firm Entry

This paper explores different fiscal stimuli within a business cycle model with an endogenous number of firms which we estimate for the U.S. economy using Bayesian techniques. We demonstrate that a changing number of firms is a crucial dimension for evaluating fiscal policy since it can both accelerate and decelerate the impacts of fiscal stimuli. When fiscal expansions cause the number of firms to decline, an additional crowding-out effect of investment in new firms results in a multiplier below that of the standard RBC model. In the presence of demand stimuli, fiscal multipliers are small and the number of firms may decline. By contrast, policies that disburden private agents from income taxes are effective in boosting economic activity and product creation.