Fiscal Management of Aggregate Demand: The Effectiveness of Labor Tax Credits

Axelle Ferriere () and Gaston Navarro ()
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Axelle Ferriere: Sciences Po & CNRS
Gaston Navarro: Federal Reserve Board

IMF Economic Review, 2025, vol. 73, issue 3, No 4, 733-778

Abstract: Abstract We use a quantitative heterogeneous agent model with nominal rigidities and unemployment risk to analyze the effectiveness of several fiscal policies in stabilizing a demand-driven recession. The model delivers empirically realistic distributions of marginal propensities to consume (mpc) and labor participation elasticities (lpe) and matches the cross-sectional incidence of unemployment risk over the business cycle. We consider three fiscal stabilization packages: (i) a transfer to all low-income households, (ii) an increase in unemployment benefits to unemployed households, and (iii) an increase in labor tax credits to low-income working households. The labor tax credit is the most effective package to attenuate the recession, as it targets both high-mpc and high-lpe households and thus jointly stimulates labor and consumption. This result holds despite the recession resulting in higher unemployment risk.

JEL-codes: E21 E62 H21 H23 H53 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1057/s41308-025-00287-w

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