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Government spending shocks, wealth effects and distortionary taxes

Cloyne, James (2014) Government spending shocks, wealth effects and distortionary taxes. CFM discussion paper series (CFM-DP2014-13). Centre For Macroeconomics, London, UK.

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Abstract

The size and sign of the government spending multiplier crucially depends on how the spending is financed and how consumers respond to implied future tax increases. I investigate this issue in an estimated New Keynesian DSGE model with distortionary labor and capital taxes and, importantly, with preferences that allow the wealth effect on labor supply to vary. Specifically I assess whether the model can explain the empirical evidence for the United States and examine the transmission mechanism, for realistic policy rules. I show that the model can match the positive empirical response of key variables including output, consumption and the real wage. I find that the role of the wealth effect on labor supply is small and that while tax rates rise following a spending shock these increases are modest, with debt rising. Deficit financed spending increases are therefore expansionary, but this is due to sticky prices rather than the wealth effect channel.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.centreformacroeconomics.ac.uk/Home.aspx
Additional Information: © 2014 The Author
Divisions: Centre for Macroeconomics
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
H Social Sciences > HJ Public Finance
JEL classification: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E20 - General
E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles
E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H20 - General
Sets: Collections > Economists Online
Research centres and groups > Centre for Macroeconomics
Date Deposited: 18 Jul 2014 15:17
Last Modified: 23 Jun 2020 23:10
URI: http://eprints.lse.ac.uk/id/eprint/58024

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