In the case of general transfer policy, the government equally distributes the additional tax revenue to all workers regardless of their employment states. Under this policy, an increase in the labor income tax rate dampens work incentives of individual workers so that the aggregate employment rate decreases by 1% compared with the benchmark economy. In the case of EITC policy, only employed workers whose labor incomes are below a certain EITC ceiling are eligible for the EITC benefits. Unlike the general transfer policy, the EITC induces low-income workers to participate the labor market to be eligible for EITC benefits. Hence, the aggregate employment rate may increase by 2.7% at the maximum. As the EITC ceiling increases, too many workers can collect the EITC but the benefits per worker becomes too little so that the increase in employment rate is negligible. By and large, this study demonstrates that EITC may effectively raise the aggregate employment rate, and that it can be a useful policy tool in response to the decrease in the labor force due to population aging as observed in Korea recently.
On the expenditure side, the literature documents a positive effect of public spending on labor market outcomes. This effect operates mainly through aggregate demand: spending on goods and services and capital spending directly affect aggregate demand and through this labor demand. The impact of the wage bill is instead more direct, as the public sector is often the largest employer in the country. For the United States, studies find positive effects on employment following a government spending shock (Fatás and Mihov 2001; Burnside et al. 2004; Cavallo 2005; Gali et al. 2003). In particu- lar, Monacelli et al. (2010) provide an empirical estimate of the unemployment multi- pliers of government spending, focusing in more detail on the transmission of fiscalpolicy to the labor market. They show that an increase in government expenditure boosts total hours, employment and the job finding probability. In a real business cycle model with competitive labormarkets and lump-sum taxation, Finn (1998) suggests that an increase in government employment could lead to lower private sector employ- ment (if the wealth effect is small) and higher real wages as well as lower private sector hours, output and investment. However, Lane and Perotti (2003) and Alesina et al. (2002) find evidence of the opposite impact. They show that an increase in government purchases and the wage bill leads to higher wages in the private sector, lower firm profits and ultimately lower employment and business investment in current and future periods. As a result, output, household income and private consumption expenditure contract. 1
The semiconductor sector (SEC), among many others, would suffer a very severe decline of more than 10% in period 0 and even after the recovery target year of period 10. Similarly, the chemical (CHM), pottery (POT), and electric power sectors (ELY) would suffer in the long run. In contrast, the textiles and apparel (TXA), metal (MET), electronic equipment (EEQ), machinery (MCH), transportation equipment (TEQ), and other manufacturing (MAN) sectors would recover in due course without any policy interventions. The petroleum sector (PET) alone would gain throughout our simulation periods owing to increased fossil fuel demand from the nuclear power
The prior mean of indexation parameter γ Y is 0.75, implying considerable output price inflation inertia, while the prior mean of nominal rigidity parameter ω Y implies an average duration of output price contracts of two years. The prior mean of capital utilization cost parameter κ is 0.10, while the prior mean of elasticity of substitution parameter ϑ is 0.75, implying that utilized capital and effective labour are moderately close complements in production. The prior mean of habit persistence parameter α is 0.95, while the prior mean of intertemporal elasticity of substitution parameter σ is 2.75, implying that consumption exhibits considerable persistence and moderate sensitivity to real interest rate changes. The prior mean of investment adjustment cost parameter χ is 5.75, implying moderate sensitivity of investment to changes in the relative shadow price of capital. The prior mean of indexation parameter γ M is 0.75, implying moderate import price inflation inertia, while the prior mean of nominal rigidity parameter ω M implies an average duration of import price contracts of two years. The prior mean of elasticity of substitution parameter ψ is 1.50, implying that domestic and foreign goods are moderately close substitutes in consumption, investment, and government consumption. The prior mean of indexation parameter γ L is 0.75, implying considerable sensitivity of the real wage to changes in consumption price inflation, while the prior mean of nominal rigidity parameter ω L implies an average duration of wage contracts of two years. The prior mean of elasticity of substitution parameter η is 2.00, implying considerable insensitivity of the real wage to changes in employment. The prior mean of the consumption price inflation response coefficient ξ π in the monetary policy rule is 1.50, while the prior mean of the output response coefficient ξ Y is 0.125, ensuring convergence of the level of consumption price inflation to its target value. The prior mean of the net foreign debt response coefficient ζ G in the fiscal expenditure rule is − 0.10, while the prior mean of the net government debt response coefficient
tending to shift it. The slope reduces as the economy becomes more open, but the reduction is relatively more for SOE. A key difference between the two kinds of economies is that the real exchange rate for the former is depreciated and tends to appreciate as development brings it closer to purchasing power parity (PPP). But there are fluctuations on the way. The stronger income effects on the terms of trade in a SOE imply that substituting these out makes the aggregate supply curve steeper. This is particularly so for an almost closed economy with a large percentage of P. Therefore it may be better to base policy on aggregate supply without substituting out the terms of trade, and use exchange rate policy to counter the shifts. We derive this variant of aggregate supply also.
The Great Recession has highlighted the role of fiscalpolicy as a counter- cyclical tool that can be deployed alongside monetary policy when the econ- omy is hit by a particularly large shock. In the aftermath of the crisis, fiscalpolicy in advanced economies went from an expansionary phase (through a wave of stimulus packages) to a consolidation phase, the latter with a view to restoring fiscal sustainability. Monetary policy, however, was thought to have remained mostly "accommodative" until the Fed’s "Taper Talk" in May 2013 and early signs of monetary policy normalization in United Kingdom. Although the exit from unconventional monetary policy is likely to be highly asynchronous across countries (with "Abenomics" 1 still unfolding in Japan and the Euro area maintaining monetary policy accommodation to support the recovery), fiscalpolicy will eventually confront the old monetary policy normal. Understanding how the stance of monetary policy affects the size of the government spending multiplier can therefore help inform our assessment of the effectiveness of fiscalpolicy in advanced economies going forward. The strong interplay between monetary and fiscalpolicy poses a challenge to both policymakers and researchers as they try to disentangle the contri- bution of each type of policy shock on the economy. Traditional models of monetary and fiscalpolicy interaction, however, have focused mainly on pol- icy coordination to provide a stable nominal anchor, in a non-cooperative game between a government and its central bank. More recently, however, a few papers have built on the new Keynesian Dynamic Stochastic GeneralEquilibrium framework to examine the size of the fiscal multiplier when the Zero Lower Bound (ZLB) on the nominal interest rate binds. The equilib- rium outcome of the interaction between active/passive monetary and fiscalpolicy has also been examined in the literature, also using the new Keynesian set-up.
Other factors that are mentioned less frequently in the literature are social security plans for unemployed or precarious workers; changes in labor market regulations, such as a reduction of working hours and incentives for early retirement; the deterioration of public services from which the formal sector benefits (Schneider and Enste, 2000); the presence of powerful unions that firms and workers prefer to avoid; and the impact of international competition (Gërxhani, 2004). Which specific policies can be implemented to reduce informality? Many authors suggest tax reduction policies, and this goes along with the opinion that high costs in the formal sector lead to a bigger informal sector. Related to the efficiency wage theory, several authors suggest that in order to increase formal employment and improve welfare, government should subsidize wages paid in the primary (formal) sector (Thierfelder and Shiells, 1997). Studies that analyze the impact of fiscal policies on informality fall into two groups: those that develop theoretical models and those that use empirical data from developed and/or developing countries.
incorporating the financial sector. They investigated the impact of firm’s balances on the investment. Choi and Cook (2004) have incorporated banking sector and examine the performance while using DSGE model. Milani (2004) contributed differently by comparing learning and the mechanical source of persistence like rational expectation in habit formation or inflation indexation. Davereux and Saito (2005) developed an alternate approach that allowed for time-varying portfolio in the DSGE models. Engel and Matsumto (2005) kept the centre of attention on complete market and included assets markets plus portfolio choice in the DSGE model. Devereux and Sutherland (2006) further investigated the issue and present a general formula for entire range of assets that is compatible with DSGE models. Fabio and Sala (2006) have added to the literature by investigating DSGE model particularly the identifiability and its repercussions for parameter estimations. An and Schorfheide (2007) revisited the related literature with DSGE and discuss at length the empirical implications of the model. Christiano, et al. (2007) extending the model into a small open economy framework and modified the model to include financial friction and fraction in the labour market. Adolfson, et al. (2008) studied DSGE with various assumptions while analysing the impact of monetary policy and transmission of shocks in the economy. They also investigate the trade-off between inflation stabilisation as well as output gap stabilisation with the help of DSGE framework.
For the transmission of fiscalpolicy three aspects turn out to be very important. First, the short-run output effects depend crucially on how specifically a fiscal instrument affects demand. While all fiscal instruments affect the budget constraints of households and thus consumption and investment, fiscal consolidation via government consumption and investment additionally reduces the government spending component of GDP directly. Second, the interaction of the fiscal instruments with private production factors matters. We find that short-run output costs are largest for consolidation via government investment and taxes on labor and capital because the former reduces the public capital stock which enters the private production function and in turn lowers productivity of private factors, while the latter two increase tax distortions. In all three cases the private or public capital stock decreases for some time which leads to a very persistent short- to medium-run output reduction. For consolidations via government consump- tion, transfers and the consumption tax rate, capital does not decrease and output recovers much faster from its short-run contraction. Differences in short-run output costs between the fiscal instruments are amplified because the more negative an instrument affects output, the larger is the adjustment of that instrument in order to ensure a decrease in the debt-to-GDP ratio to compensate the output contraction. Third, the presence of credit-constrained households mat- ters and fiscal consolidation has large distributional consequences between credit-constrained and optimizing households. Consumption of credit-constrained households drops directly if their budget constraint tightens because of lower transfers, higher labor taxes or reductions in hours worked caused by lower production. Optimizing households, by contrast, can smooth
Formally, economy is described as a dynamic system. It reflects a short-term equilibrium in at least two meanings. Firstly, in each point of time economy reflects a generalequilibrium as understood by Walras. It is, thus, assumed that prices always clear the markets. Secondly, economic agents make optimal decisions, i.e. ex post they do not make mistakes in a systematic manner as to the actions undertaken. In that meaning their decisions are called rational. Should it appear ex post that the decisions of the agents are not the best possible to be taken, this is only due to information gap, i.e. due to the fact that after the moment of making the decision an event occurred that could not have been foreseen by the agent, e.g. an unexpected exogenous growth in productivity took place. The agents build expectations as to the future values of economic variables through the operator of conditional expected value. In that sense the mechanism of building expectations by the economic agents is rational. It is, therefore, assumed that agents know the complete model of economy, namely that they know (the real) principles governing the world in which they live and the values of all of its parameters. They are also able, based on the model, to set out optimal decision-making rules for all agents and apply them, which would require in practice the possibility of making a perfect filtration, i.e. a perfect measurement of the value of all of the variables and shocks impacting the economy in any period. That omnipresent transparency and rationality draws critique on the part of alternative paradigms of economic modelling such as multi-agent modelling (agent-based computational economics), see Fagiolo and Roventini (2008).
stabilization role for monetary policy, which is generally implemented through control of the nominal interest rate according to a monetary policy rule. The persistence of the effects of monetary policy shocks on output and inflation is often enhanced with other features such as habit persistence in consumption, adjustment costs in investment, and variable capital utilization. Early examples of closed economy DSGE models incorporating some of these features include those of Yun (1996), Goodfriend and King (1997), Rotemberg and Woodford (1995, 1997), and McCallum and Nelson (1999), while recent examples of closed economy DSGE models incorporating all of these features include those of Christiano, Eichenbaum and Evans (2005), Altig, Christiano, Eichenbaum and Linde (2005), and Smets and Wouters (2003, 2005).
and higher value added tax rates do not affect the equilibrium unemployment rate in the long run. A higher replacement rate of unemployment benefi ts increases unem- ployment and a tax reform containing lower marginal and average tax rates reduce unemployment. Sørensen (1997) investigates structural unemployment in Europe and simulates a CGE model to conclude that a tax shift away from low skilled labor may raise aggregate employment and welfare while increasing the progressivity of the labor income tax. A dynamic CGE analysis of Danish tax reform is in the main focus of Knudsen et al. (1998) paper. The reform is strict Pareto improvement in the sense that all current and future generations are better off after the reform. Hutton and Ruocco (1999) apply multi-country CGE model to examine to what extent mod- ifi cations of tax systems in the EU contributed to changes in labor market. Several fi ndings emerged, but their main conclusion indicates that labor market of different EU countries react to changes in rates of VAT and personal income tax.
The purpose of the paper is to review and analyze the fiscal expenditures effects of fiscal rules simulation on Bolivia’s economy. But, Bolivia doesn’t have any fiscal rule; so, different fiscal rules imposition or simulation will help us to assess the performance of the fundamentals in the economy through the fiscalpolicy mechanism. Thus, we reach our objective using a dynamic stochastic generalequilibrium (DSGE) model with the New Keynesian macroeconomic vintage for a small open economy (SOE) and applying different types of shocks.
model variables over time when a shock hits variables. Figure 2 shows the IRFs based on a positive shock to international institutions. It indicates that with the onset of the shock, the amount of foreign aid to Afghanistan has increased, and in the first place, it has had a positive effect on the government’s monetary policy, and as an index, has grown the government expenditure by about 50 percent. In other words, the positive shock in foreign aid will give the government a fiscal expansion policy, which will allow increasing its investment in development projects. Consequently, it has affected production and, in the first place, represented a positive impact by as much as six percent in GDP. By reducing the impact of this shock over time, its effects on government production expenditures reach their steady state.
Our analysis also uncovers a decline in output in response to positive fiscal shock in the form of higher taxes. Domestic output declines in the beginning and remain below its steady state for a short period. Output came back to its steady state and rises for two quarters and again die out very quickly. There are different transmission channels through which fiscalpolicy shocks, tax shocks, affect output. Imposition of higher tax has legitimate economic and business cost. Higher taxes increase price level. Higher prices and inflationary pressure in the economy discourage productive activities and causes output to fall. Higher taxes also discourage labor supply and employees have less incentive to work and earn more. Furthermore, tax shocks also distort price signals and compel rational agent to substitute goods bearing lower taxes. Similarly higher taxes discourage producers to invest and accumulate capital further. This implies that tax shocks slow the process of economic growth and cause the domestic output to decline. The findings are very much consistent with the standard economic literature.
This section of the paper presents the three policy simulations run on the contemporaneous dynamic CGE model to assess the effect of expansionary fiscalpolicy on the macroeconomy. The first CGE simulation (Scenario 4) examines the economy-wide impact of public expenditure on i) demand-side components of economic activity ii) GDP at market prices and iii) the Gini coefficient. The second CGE simulation (Scenario 5) evaluates the impact of fiscal expansion on the household consumption patterns for the 12 deciles of income groups. The third CGE simulation (Scenario 6) evaluates the impact of fiscal expansion on employed people with different levels of educational attainment (i.e. primary, middle, secondary and tertiary). Tables 3, 4 and 5 report the simulation results for scenario 4, 5 and 6, respectively, and within these tables the effect of a 5% increase in government spending is reported in panel A whereas the effect of a 10% increase in government spending is presented in panel B. The reported results quantify the effect of these two shocks which are reported as percentage changes between the values in the baseline run (2015) and the policy run (2018, 2019, 2020) for each variable. Starting with the results from the first CGE simulation (Scenario 4) in Table 3, we note that both a 5% and 10% fiscal shock improves investment and transfer payments to households with the effect being higher in investment than on household consumption throughout the policy run periods of 2018 to 2020. These results are not surprising as governments tends to invest in infrastructure that improves conditions for businesses to create value and develop innovative business ideas (Decaluwé et al., 2005). These, in turn, exert spillover effects to the trade sector as reflected by increased import and export activity. Further note that the effect of government spending on GDP is positive but minute and these findings are comparable to those in Mabugu et al. (2013) who similarly find South African expansionary fiscalpolicy to have a positive but very slight effect on GDP. Another interesting result from the model is that government spending contributes positively (but close to zero) to the reduction of income inequality, measured by the Gini coefficient. However, this effect is very small and almost negligible, with the percentage reduction in inequality being below 0.00% from 2018 to 2020.
η = 0 meaning that households are indiﬀerent to the path of labor supplied . Although there is little doubt that the marginal disutility of labor rises with the amount of labor provided per working day, it seems doubtful that most people have strong preferences in favor of labor smoothing over their wage contract period. On the contrary, many people prefer to bunch their overtime work, in order to make room for free time (shopping days, holidays). The intertemporal substitution of labor relevant to our analysis is that which occurs over the contract period, and in this context there may be little preference for labor smoothing 8 .In any case, our results under positive values of η are given in the next section.
GLSV) add rule-of-thumb agents to a standard new-Keynesian model. They show that both price stickiness and the presence of rule-of-thumb consumers are necessary elements in order to have a positive response of private consumption for reasonable calibrations of the parameters. ”Rule-of-thumb consumers partly insulate aggregate demand from the negative wealth effects generated by the higher levels of (current and future) taxes needed to finance the fiscal expansion, while making it more sensitive to current disposable income. Sticky prices make it possible for real wages to increase (or, at least, to decline by a smaller amount) even in the face of a drop in the marginal product of labor, as the price markup may adjust sufficiently downward to absorb the resulting gap. The combined effect of a higher real wage and higher employment raises current labor income and hence stimulates the consumption of rule-of-thumb
The dynamic paths which technology, monetary policy, and ﬁscal policy shocks take toward macro variables are reported in Figures 2 – 4 . In Figure 2 , a positive technology shock means the technological progress of production in an economy. Other things being equal, with technological progress, the same factor inputs will produce more output, or lower factor inputs will result in the same level of production. Capital stock increases follow rising investment in the wake of technological progress. Capital stock accumulates smoothly, and goes back to a steady-state slowly. The peak eﬀect of capital accumulation is an increase of approximately 80% after about 10 quarters. Labor supply increases at a rate of about one-half that of capital stock, and then decreases sharply, after 3 quarters it falls below steady-state value then slowly converges on 0. Finally, output and consumption will increase and then shopping time goes upward. Similar to the conventional RBC results, investment and output are more volatile than consumption.
These estimated responses are consistent with a new-keynesian framework but not with an RBC-style model. Inconsistencies with the latter lie not only in the positive response of private consumption following a government expenditure shock, but also in the (mild) increase of real wages after a shocks to c g t , as the wealth effect brings about an increase in employment that in turn should imply a decrease in the marginal productivity of labor and in real wages. The increase (or stability) in real wage that we find is therefore possible only if there is an outward shift in labor demand. Finally, after a government employment shock, private employment increases on impact, although mildly, reflecting the keynesian effect on labor demand via an increase in consumption and output. In fact, in an RBC-style model, for reasonable calibrations of the param- eters, the increase in labor supply due to the standard wealth effect after an increase in public spending cannot compensate for the increased labor demand from the gov- ernment, so that private sector employment would decrease on impact. The increase in private sector employment that we find is therefore due to the contemporaneous shift in labor demand as price markups get reduced (to accommodate a higher goods demand under sticky prices). This keynesian effect, however, does not last long and after roughly four quarters employment in the private sector starts reducing.