Production Subsidy as a Macroeconomic Policy in a Stagnation Economy

This paper analyzes the effects of a changing production subsidy in a model with money-in-the-utility function for households, monopolistic competition amongst an endogenously-determined number of firms, and nominal wage sluggishness that can prevent the equilibrium from attaining full employment. Its conclusion is that in a steady state with less than full employment (that is, under stagnation), a larger production subsidy will promote entry and stimulate effective demand provided that the elasticity of substitution among the differentiated products is sufficiently high. This paper is motivated by recent Japanese experiences