Fiscal Stimulus with Imperfect Expectations: Spending vs. Tax Policy

Riccardo Bianchi Vimercati, Martin Eichenbaum and Joao Guerreiro

No 29134, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper addresses the question: how sensitive is the power of fiscal policy at the ZLB to the assumption of rational expectations? We do so through the lens of a standard NK model in which people are dynamic-level-k thinkers. Our analysis weakens the case for using government spending to stabilize the economy when the ZLB binds. The less sophisticated people are, the smaller the government-spending multiplier is. Our analysis strengthens the case for using tax policy to stabilize output when the ZLB is binding. The power of tax policy to stabilize the economy during the ZLB period is essentially undiminished when agents do not have rational expectations. Our results are robust to whether or not Ricardian equivalence holds. Finally, we show that the way in which tax policy is communicated is critical to its effectiveness.

JEL-codes: E0 E32 E62 (search for similar items in EconPapers)
Date: 2021-08
New Economics Papers: this item is included in nep-dge, nep-isf and nep-mac
Note: EFG ME
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Citations: View citations in EconPapers (5)

Published as Bianchi-Vimercati, Riccardo & Eichenbaum, Martin & Guerreiro, Joao, 2024. "Fiscal stimulus with imperfect expectations: Spending vs. tax policy," Journal of Economic Theory, Elsevier, vol. 217(C).

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Journal Article: Fiscal stimulus with imperfect expectations: Spending vs. tax policy (2024)
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