Working Paper: CEPR ID: DP9088
Authors: Florin Ovidiu Bilbiie; Tommaso Monacelli; Roberto Perotti
Abstract: In an economy with financial imperfections, Ricardian equivalence holds when prices are flexible and the steady-state distribution of consumption is uniform, or labor is inelastic. With different steady-state consumption levels, Ricardian equivalence fails, but tax cuts, somewhat paradoxically, are contractionary; the present-value multiplier on consumption is, however, zero. With sticky prices, Ricardian equivalence always fails. A Robin-Hood, revenue-neutral redistribution to borrowers is expansionary on aggregate activity. A uniform cut in taxes financed with public debt has a positive present-value multiplier on consumption, stemming from intertemporal substitution by the savers, who hold the public debt.
Keywords: borrowing constraint; public debt; redistribution; tax cuts
JEL Codes: E44; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tax cut favoring borrowers (H20) | contraction in aggregate consumption (E20) |
| uniform steady-state distribution of consumption (D15) | Ricardian equivalence holds (E62) |
| non-uniform steady-state distribution of consumption (D15) | tax cut favoring borrowers results in contraction in aggregate consumption (E62) |
| revenue-neutral tax redistribution under sticky prices (H23) | increases aggregate spending and inflation (E62) |
| uniform tax cut financed by public debt (H69) | positive present-value multiplier on consumption (E21) |
| flexible prices (P22) | present-value multiplier is zero (G19) |