Monetary Policy and Automatic Stabilizers: the Role of Progressive Taxation

We study the effects of progressive labor income taxation in an otherwise standard NK model. We show that progressive taxation (i) introduces a trade-off between output and inflation stabilization and affects the slope of the Phillips Curve; (ii) acts as automatic stabilizer changing the responses of the economy to technology shocks and demand shocks (iii) alters the prescription for the optimal discretionary interest rate rule. We also show that the welfare gains from commitment decrease as labor income taxes become more progressive. Quantitatively, the model is able to reproduce the observed negative correlation between the volatility of output, hours and in?ation and the degree of progressivity of labor income taxation.

Monetary Policy and Automatic Stabilizers, the Role of Progressive Taxation

We study the effects of progressive labor income taxation in an otherwise standard NK model. We show that progressive taxation (i) introduces a trade-o¤ between output and inflation stabilization and affects the slope of the Phillips Curve; (ii) acts as automatic stabilizer changing the responses to technology shocks and demand shocks (iii) alters the prescription for the optimal monetary policy. The welfare gains from commitment decrease as labor income taxes become more progressive. Quantitatively, the model reproduces the observed negative correlation between the volatility of output, hours and inflation and the degree of progressivity of labor income taxation

Monetary and fiscal policy under deep habits

Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. We explore this consensus assignment in an economy subject to ‘deep’ habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially nonlinear) policy rules to mimic fully optimal policy.Monetary Policy, Fiscal Policy, Deep Habits, New Keynesian

Monetary and Fiscal Policy under Deep Habits

Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. We explore this consensus assignment in an economy subject to ‘deep’ habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially non¬linear) policy rules to mimic fully optimal policy.Monetary Policy, Fiscal Policy, Deep Habits, New Keynesian.

Optimal income taxation with endogenous participation and search unemployment

This paper characterizes the optimal redistributive taxation when individuals are heterogeneous in two exogenous dimensions : Their skills and their values of non-market activities. Search-matching frictions on the labor markets create unemployment. Wages, labor demand and participation are endogenous. The government only observed wage levels. Under a Maximin objective, if the elasticity of participation decreases along the distribution of skills, at the optimum, the average tax rate is increasing, marginal tax rates are positive everywhere, while wages, unemployment rates and participation rates are distorted downwards compared to their laissez-farie values. A simulation exercise confirms some of these properties under a general utilitarian objective. Taking account of the wage-cum-labor demand margin deeply changes the equity-efficiency trade-off.Non-linear taxation, Redistribution, Adverse selection, Random participation, Unemployment, Labor market frictions

Optimal Income Taxation with Endogenous Participation and Search Unemployment

This paper characterizes the optimal redistributive taxation when individuals are heterogeneous in two exogenous dimensions: their skills and their values of non-market activities. Search-matching frictions on the labor markets create unemployment. Wages, labor demand and participation are endogenous. The government only observes wage levels. Under a Maximin objective, if the elasticity of participation decreases along the distribution of skills, at the optimum, the average tax rate is increasing, marginal tax rates are positive everywhere, while wages, unemployment rates and participation rates are distorted downwards compared to their laissez-faire values. A simulation exercise confirms some of these properties under a general utilitarian objective. Taking account of the wage-cum-labor demand margin deeply changes the equity-efficiency trade-off.non-linear taxation, redistribution, adverse selection, random participation, unemployment, labor market frictions

An Interview with Thomas J. Sargent

The rational expectations hypothesis swept through macroeconomics during the 1970’s and permanently altered the landscape. It remains the prevailing paradigm in macroeconomics, and rational expectations is routinely used as the standard solution concept in both theoretical and applied macroeconomic modelling. The rational expectations hypothesis was initially formulated by John F. Muth Jr. in the early 1960s. Together with Robert Lucas Jr., Thomas (Tom) Sargent pioneered the rational expectations revolution in macroeconomics in the 1970s. We interviewed Tom Sargent for Macroeconomic Dynamics .

Sharing Demographic Risk – Who is Afraid of the Baby Bust?

We model the optimal reaction of a public PAYG pension system to demographic shocks. We compare the ex-ante first best and second best solution of a Ramsey planner with full commitment to the outcome under simple third best rules that mimic the pension systems observed in the real world. The model, in particular the pension system, is calibrated to the German economy. The objective of the social planner is calibrated such that the size of the German pension system was optimal under the economic and demographic conditions of the 1960s. We find that the German system comes relatively close to the second-best solution, especially when labor market distortions are correctly modelled. Furthermore, the German system and a constant contribution rate lead to a lower variability of lifetime utility than does the second best policy. The recent baby-boom/baby-bust cycle leads to welfare losses of about 5% of lifetime consumption for some cohorts. We argue that it is crucial for these results to model correctly the labor market distortions arising from the pension system.

Labour supply and taxes

In this paper we provide an overview of the literature relating labour supply to taxes and welfare benefits with a focus on presenting the empirical consensus. We begin with a basic continuous hours model, where individuals have completely free choice over their hours of work. We then consider fixed costs of work, the complications introduced by the benefits system, dynamic aspects of labour supply and we place the analysis in the context of the family. The key conclusion of this work is that in order to estimate the impact of tax reform and be able to generalise results, a structural approach that takes account of many of these issues is desirable. We then discuss the 'new Tax Responsiveness' literature which uses the response of taxable income to the marginal tax rate as a summary statistic of the behavioural response to taxation. Underlying this approach is the unsatisfactory nature of using hours as a proxy for labour effort for those with high levels of autonomy on the job and who already work long hours, such as the self employed or senior executives. After discussing relevant theory we then provide a summary of empirical estimates and the methodology underlying the studies. Our conclusion is that hours of work are relatively inelastic for men, but are a little more responsive for married women and lone mothers. On the other hand, participation is quite sensitive to taxation and benefits for women. Within this paper we present new estimates form a discrete participation model for both married and single men based on the numerous reforms over the past two decades in the UK. We find that the participation of low education men is somewhat more responsive to incentives than previously thought. For men with high levels of education, participation is virtually unresponsive; here the literature on taxable income suggests that there may be significant welfare costs of taxation, although much of this seems to be a result of shifting income and consumption to non-taxable forms as opposed to actual reductions in work effort