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Catching with the Keynesians

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Abstract

This paper examines the role for tax policies in productivity-shock driven economies with \"catching-up-with-the-Joneses\" utility functions. The optimal tax policy is shown to affect the economy counter-cyclically via procyclical taxes, i.e., \"cooling down\" the economy with higher taxes when it is \"overheating\" in booms and \"stimulating\" the economy with lower taxes in recessions to keep consumption up. Thus, models with catching-up-with-the-Joneses utility functions call for traditional Keynesian demand management policies. Parameter values from Campbell and Cochrane (1995) are also used to illustrate that the necessary labor taxes can be very high, in the order of 50 percent. However, Campbell and Cochrane's nonlinear version of the aspiration level in the catching-up-with-the-Joneses preferences has the additional implication that consumption bunching can be welfare enhancing.

Suggested Citation

  • Lars Ljungqvist & Harald Uhlig, 1996. "Catching with the Keynesians," Working Paper Series, Macroeconomic Issues WP-96-15, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhma:wp-96-15
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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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