Non-Linear Employment Effects of Tax Policy

We study the non-linear propagation mechanism of tax policy in a heterogeneous agent equilibrium business cycle model with search frictions in the labor market and an extensive margin of employment adjustment. The model exhibits endogenous job destruction and endogenous hiring standards in the form of occasionally-binding zero-surplus constraints. After parameterizing the model using U.S. data, we find that the dynamic response of employment to a temporary change in the labor income tax is highly non-linear, displaying sizable asymmetries and state-dependence. Notably, the response to a tax rate cut is at least twice as large in a recession as in an expansion.

Collateral Constraints, Wage Rigidity, and Jobless Recoveries

The Great Recession has drawn attention to the importance of macro-financial linkages. In this paper I explore the joint role of imperfections in labor and financial markets for the cyclical adjustment of the labor market. I show that jobless recoveries emerge when, upon exiting a recession, firms are faced with deteriorating credit conditions. On the financial side, collateral requirements affect the cost of borrowing for firms. On the employment side, hiring frictions and wage rigidity increase the need for credit, making the binding collateral constraint more relevant. In a general equilibrium business cycle model with search and matching frictions, I illustrate that tightening credit conditions calibrated from data negatively affect employment adjustments during recovery periods. Wage rigidity substantially amplifies this mechanism, generating empirically plausible fluctuations in employment and output.

Transmission of Monetary Policy with Heterogeneity in Household Portfolios

This paper assesses the importance of heterogeneity in household portfolios for the transmission of monetary policy in a New Keynesian business cycle model with uninsurable income risk and assets with different liquidity. In this environment, monetary transmission works through investment, but redistribution lowers the elasticity of investment via two channels: (i) heterogeneity in marginal propensities to invest, and (ii) time variation in the liquidity premium. Monetary contractions redistribute to wealthy households who have high propensities to invest and a low marginal value of liquidity, thereby stabilizing investment. I provide empirical evidence for countercyclical liquidity premia and heterogeneity in household portfolio responses. (JEL E12, E32, E52, G11, G51)

A Real-Business-Cycle Model with Institutional Quality: The Case of Bulgaria (1999–2018)

This paper takes an otherwise standard real-business-cycle (RBC) setup with government sector, and augments it with an output-expropriation mechanism and shocks to institutional quality in order to study business cycle fluctuations. The extraction decision is endogenous: households can use their time either productively, or engage in opportunistic activities. Stronger institutions decrease the size of the available resources for capture, and suppress corrupt behavior. As a test case, the model is calibrated to Bulgaria after the introduction of the currency board (1999–2018). Overall, the shocks to institutional quality generate business cycles of the same magnitude as in data, which suggests that political economy factors might be the major driving force behind the observed economic fluctuations in Bulgaria. Another interesting result, generated by the model, is that on average, the estimated size of evaded resources is approximately one-fourth of output, which is very close to the estimates of the unofficial economy share, e.g. European Commission (2014). Special eurobarometer 402: undeclared work. European Commission, Brussels and Medina, L. and Schneider, F. (2017). Shadow economies around the world: what did we learn over the last 20 Years? IMF Working Paper WP/18/17. International Monetary Fund, Washington DC.

PROGRESSIVE TAXATION AND MACROECONOMICS (IN)STABILITY UNDER HOUSEHOLD HETEROGENEITY

It has been shown that progressive income taxation may stabilize an otherwise standard representative-agent real business cycle model with an indeterminate steady state against aggregate fluctuations caused by agents’ animal spirits. By contrast, within an identical model that allows for sustained economic growth, progressive taxation could lead to equilibrium indeterminacy and sunspot-driven fluctuations. In the context of household heterogeneity that gives rise to income and asset inequality, the fiscal authority has (at least) two options of setting the baseline level of taxable income: (i) the economy-wide average level of income and (ii) the economy’s steady-state level of per capita income. I show that the adoption of a fiscal rule (i) invalidates the effects that a progressive tax can exert on the model’s local stability properties. Progressive income taxation thus no longer operates as an automatic stabilizer that mitigates belief-driven cyclical fluctuations in a no-growth economy, nor as an automatic destabilizer that leads to local indeterminacy in a sustained-growth economy. If a tax policy rule (ii) is instead adopted, then the existing literature’s findings of the (de)stabilizing roles of progressive taxation are robust to the inclusion of household heterogeneity.