Aggregate implications of the progressivity of fiscal transfers : a heterogeneous-agents approach

Abstract

This paper introduces the progressivity of fiscal transfers into an otherwise standard heterogeneousagents (HA) model and shows how this feature has a significant effect on the aggregate dynamics following the windfall of fiscal transfers. A larger Marginal Propensity to Consume (MPC) in the lower part of the income and wealth distribution implies that more progressivity generates a stronger response of consumption and a weaker response of investment, which leads to less capital accumulation after the windfall. This paper has two main contributions. First, it studies the progressivity effects using a model in which the distribution of MPCs is endogenous, as opposed to the usual assumptions found in the previous literature that explores transitional dynamics. The second contribution is a relatively simple method to analyze distributional aspects of fiscal policy in continuous-time HA models, that has rich economic interpretation besides progressivity.