SSE/EFI Working Paper Series in Economics and Finance
No 319:
Fiscal Policy with Heterogeneous Agents and Incomplete Markets
Jonathan Heathcote
Abstract: I undertake a quantitative investigation into the short
run effects of changes in the timing of taxes for a model economy in which
heterogeneous households trade only one asset and face a borrowing
constraint. This asset market structure implies that the consumption of low
wealth households is sensitive to tax changes. The main finding of the
paper is that when the wealth distribution in the model resembles that in
the United States, market incompleteness accounts for large immediate
aggregate consumption increases following tax cuts, and large consumption
falls following tax increases. When taxes are lump-sum, for example, a
dollar change in tax revenue is associated with a 15 cent change in
aggregate consumption, compared to a response of roughly one third this
size when markets are complete but households are finitely-lived. I find
the response to tax changes to be larger if the interest rate is constant
rather than determined endogenously, and smaller if taxes are proportional
rather than lump-sum.
Keywords: Fiscal policy; heterogeneous agents; incomplete markets; Ricardian equivalence; borrowing constraints.; (follow links to similar papers)
JEL-Codes: E21; E25; E62; (follow links to similar papers)
42 pages, May 19, 1999, Revised July 28, 1999
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