Subsidies as Optimal Fiscal Stimuli

19 Pages Posted: 11 Dec 2012

See all articles by Hassan Molana

Hassan Molana

University of Dundee

Catia Montagna

University of Aberdeen; SIRE; GEP, Nottingham

Chang Yee Kwan


Date Written: December 2012


Theoretical macroeconomic models typically take fiscal policy to mean tax‐and‐spend by a ‘benevolent government’ that exploits potential aggregate demand externalities inherent in the imperfectly competitive nature of goods markets. Whilst shown to raise aggregate output and employment, these policies crowd‐out private consumption and typically reduce welfare. On account of their widespread use to stimulate economic activity, we consider the use of ‘tax‐and‐subsidize’ instead of ‘tax‐and‐spend’ policies. Within a static general equilibrium macro‐model with imperfectly competitive goods markets, we examine the effects of wage and output subsidies and show that, for a small open economy, positive tax and subsidy rates exist which maximize welfare, rendering no intervention suboptimal. We also show that, within a two‐country setting, a Nash non‐cooperative symmetric equilibrium with positive tax and subsidy rates exists, and that cooperation between governments in setting these rates is more expansionary and leads to an improvement upon the non‐cooperative solution.

Keywords: fiscal policy, international trade, monopolistic competition, Nash equilibrium, policy coordination, welfare

JEL Classification: E24, E62, F41

Suggested Citation

Molana, Hassan and Montagna, Catia and Kwan, Chang Yee, Subsidies as Optimal Fiscal Stimuli (December 2012). Bulletin of Economic Research, Vol. 64, pp. s149-s167, 2012. Available at SSRN: or

Hassan Molana (Contact Author)

University of Dundee ( email )

Dundee, Scotland DD1 4HN
United Kingdom
01382 344375 (Phone)

Catia Montagna

University of Aberdeen ( email )

Business School
Edward Wright Building
Aberdeen, Scotland AB243QJ
United Kingdom
+44 1224 273690 (Phone)

SIRE ( email )

First floor - Room 1.10
31 Buccleuch Place
Edinburgh, Scotland EH8 9JT
United Kingdom

GEP, Nottingham ( email )

Chang Yee Kwan

Independent ( email )

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