Fiscal policy and entrepreneurship

Abstract

This paper reexamines the effect of expansionary fiscal policy on real GDP in the presence of entrepreneurship when government expenditure partially crowds out private consumption. As government expenditure cannot reflect changes in consumers’ tastes, expansionary fiscal policy weakens the social role of firms’ activities to predict and adapt to idiosyncratic changes in consumers’ taste. I show that expansionary fiscal policy can lower real GDP when idiosyncratic risk and the substitutability of goods are large and when firms have a strong ability to predict changes in consumer tastes. I also investigate how expansionary fiscal policy influences firms’ investments in prediction ability.