Keynesian Multipliers and the Cost of Public Funds Under Monopolistic Competition

Abstract: We extend macroeconomic models of imperfect competition with Keynesian features to allow for non-unitary elasticities between leisure and consumption and the effect of product variety on multipliers and welfare. We find that the real national income multiplier for a given rise in real public spending under free entry and exit is larger than under restricted entry and exit of firms, so that private consumption is crowded out more in the short than in the long run. This implies a pro-cyclical real consumer wage. We also show that with lump-sum taxes the marginal cost of public funds is below unity, more so in the long run than in the short run especially if substitution between consumption and leisure is easy. More priority for public goods raises the cost of public funds in the long run. If private consumption goods are necessities, the income multiplier and the cost of public funds are smaller. Imperfect competition in the labour market boosts the Keynesian multipliers. Fiscal consolidation, i .e. trimming the public sector and cutting the tax on labour, boosts employment unless the income effect dominates the substitution effect in labour supply. JEL codes: E0, H0 Keywords: monopolistic competition, love for variety, returns to scale, entry and exit, Keynesian multipliers, real consumer wage, marginal cost of public funds, provision of public goods, distortionary tax, fiscal consolidation;