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Rule-of-Thumb Consumers and Labor Tax Cut Policy at the Zero Lower Bound

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  • Lorant Kaszab

    (Central Bank of Hungary)

Abstract

This paper shows that a labor tax cut can increase output in a model where the zero lower bound on the nominal interest rate binds due to a negative demand shock. The model is a basic New Keynesian one with non-Ricardian (also known as rule-of-thumb) households (along with the usual Ricardian ones) who spend the increase in their disposable income after the tax cut. Besides price rigidity, our result requires wage rigidity which attenuates the effect of the negative demand shock on the real wage. This finding stands in contrast to those of Eggertsson (2011) and Christiano, Eichenbaum, and Rebelo (2011), whose models support an increase in the labor tax. This paper departs from the assumption of balanced government budget with lump-sum taxes and introduces endogenous debt that is retired by taxes on labor income. It is shown that the tax-cut policy is most effective when debt is paid back far in the future.

Suggested Citation

  • Lorant Kaszab, 2016. "Rule-of-Thumb Consumers and Labor Tax Cut Policy at the Zero Lower Bound," International Journal of Central Banking, International Journal of Central Banking, vol. 12(3), pages 353-390, September.
    • Handle: RePEc:ijc:ijcjou:y:2016:q:3:a:8
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    Cited by:

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    2. Bhatnagar, Aryaman, 2023. "Monetary policy with non-Ricardian households," The Quarterly Review of Economics and Finance, Elsevier, vol. 89(C), pages 12-26.
    3. Liu, Shih-fu & Huang, Wei-chi & Lai, Ching-chong, 2022. "The Paradox of Toil at the Zero Lower Bound in a TANK Model," European Economic Review, Elsevier, vol. 148(C).
    4. Horvath, Roman & Kaszab, Lorant & Marsal, Ales & Rabitsch, Katrin, 2020. "Determinants of fiscal multipliers revisited," Journal of Macroeconomics, Elsevier, vol. 63(C).
    5. Liu, Shih-fu & Huang, Wei-chi & Lai, Ching-chong, 2020. "Could Fiscal Policies Overcome a Deep Recession at the Zero Lower Bound?," MPRA Paper 101282, University Library of Munich, Germany.
    6. de Beauffort, Charles, 2023. "When is government debt accumulation optimal in a liquidity trap?," Journal of Economic Dynamics and Control, Elsevier, vol. 147(C).

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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