The macroeconomics of TANSTAAFL

Market imperfections may lead to underinvestment in dynamic general equilibrium models. An interesting but unexplored question is whether policy interventions which attenuate underinvestment gaps necessarily imply that consumption will initially decline. By employing a calibrated version of a standard R&D-based growth model, we show that raising the R&D subsidy rate may not only close the R&D underinvestment gap but also raise consumption per capita at all times (“intertemporal free lunch”). We also discuss the general mechanics of such an intertemporal free lunch in both one-sector and multi-sector growth models and further examples.