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

Axelle Ferriere () and Gaston Navarro
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Axelle Ferriere: ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CNRS - Centre National de la Recherche Scientifique
Gaston Navarro: Federal Reserve Bank of Richmond

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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.

Keywords: Business Cycle; Redistribution; Optimal Taxation; Fiscal Policy; Heterogeneous Agents (search for similar items in EconPapers)
Date: 2025-09-10
Note: View the original document on HAL open archive server: https://sciencespo.hal.science/hal-05446602v1
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Published in IMF Economic Review, 2025, International Monetary Fund Economic Review, 73 (3), pp.733-778. ⟨10.1057/s41308-025-00287-w⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05446602

DOI: 10.1057/s41308-025-00287-w

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