Macroeconomics and Monetary Economics

This paper studies how the business cycle, joint with inflation and macroeconomic uncertainty, determines the impact of tax news on output.

Utilizing tax news data identified from the municipal bond market and employing a Smooth Transition local projection, we find that the output effect of tax news is business cycle state-dependent. News about future tax cuts is more contractionary in recessions. This negative impact on output is more pronounced and persistent in recessions characterized by low inflation or high macroeconomic uncertainty. However, there is no evidence of different output responses based on inflation or uncertainty in low unemployment periods. The study suggests that countercyclical tax policy changes in recessions can have unintended negative effects during anticipation periods, depending on the sources of business cycle and the degree of uncertainty.

The effects of tax news shock depend upon the state of the economy when the news arrives. Research trying to explore various state indexes faces the problem of small samples. The method of smooth transition local projection utilizes full sample for every estimation and allows this paper to analyze various state indexes, including unemployment, uncertainty, debt, and whether interest rates are near the zero lower bound. To identify the tax news shock, I exploit the yield spread between municipal bonds and treasury bonds. This paper then estimates the state-dependent effects of a tax news shock in the states with the 1954-2020 U.S. quarterly data. I find that the news about higher future tax rates is more ex- pansionary during high unemployment, high uncertainty, or low-debt time, but less expansionary when interest rates are near zero. The nonlinear output responses are largely driven by the heterogeneous responses of investment and hours across states.

An increase in nominal interest rates, through the monetary policy that follows the generalized Taylor rule, can be resulted from either a lower inflation target of central bank or an exogenous monetary policy shock. Given the different motivations of monetary policy, how different are its effects on the economy? Using in a simple New Keynesian model, this paper simulates the effects of a negative inflation target shock on the macroeconomic variables and compare with the effects of a positive shock on nominal interest rate. First, a negative in- flation target shock and a positive exogenous monetary policy shock generate similar impulse responses of output and hours of work, although the inflation target shock is more effective in reducing inflation. Second, the inflation target shock explains majority of the variations of the macroeconomic variables. Finally, when inflation target is permanent or when monetary policy responds directly to changes in inflation target the effects of the inflation target shock are more substantial.

This paper differentiates the effects of a labor tax cut on output when nominal interest rates are stuck at the zero lower bound from the normal state of positive interest rates. I simulate the effects of an exogenous labor tax cut, in a New Keynesian model, during the time of zero lower bound on interest rates and the time of positive interest rates, and compute the tax cut multipliers for both states. The simulation shows that labor tax cuts are less expansionary during the time of zero interest rates than when interest rates are positive. When interest rates are positive, they have more room to decrease in response to the tax cut, compared with when nominal interest rates are stuck at zero. Under the zero lower bound state, therefore, the decrease in real interest rates is smaller. Hence, output gain from the tax cut is also smaller. Additionally, the cumulative tax cut multiplier under the the zero lower bound state is significantly smaller than in the normal state (0.37 and 0.44).