Working Paper: CEPR ID: DP15623
Authors: Jesper Lind; Matthieu Lemoine
Abstract: Recent influential work argue that a gradual increase in sales tax stimulates economic activity in a liquidity trap by boosting inflation expectations. Higher public infrastructure investment should also be more expansive in a liquidity trap than in normal times by raising the potential interest rate and increasing aggregate demand. We analyze the relative merits of these policies in New Keynesian models with and without endogenous private capital formation and heterogeneity when monetary policy does not respond by raising policy rates. Our key finding is that the effectiveness of sales tax hikes differs notably across various model specifications, whereas the benefits of higher public infrastructure investment are more robust in alternative model environments. We therefore conclude that fiscal policy should consider public investment opportunities and not merely rely on tax policies to stimulate growth during the COVID-19 crisis.
Keywords: monetary policy; sales tax; public investments; liquidity trap; zero lower bound; DSGE model
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| gradual increase in sales tax (H25) | increased consumption (E21) |
| gradual increase in sales tax (H25) | boost in inflation expectations (E31) |
| higher public infrastructure investment (H54) | increased economic activity (F69) |
| higher public infrastructure investment (H54) | raise potential interest rate (E43) |
| higher public infrastructure investment (H54) | increase aggregate demand (E00) |
| gradual increase in sales tax (H25) | adjustments in other tax rates (H29) |
| adjustments in other tax rates (H29) | maintain balanced budget (H61) |