Short-Run Fiscal Policy: Welfare, Redistribution, and Aggregate Effects in the Short and Long Run

Abstract

This paper quantifies the effects of two short-run fiscal policies, a temporary tax cut and a temporary rebate transfer, that are intended to stimulate economic activity. A reduction in income taxation provides immediate incentives to work and save more, raising aggregate output and consumption. A temporary rebate is mostly saved and increases consumption marginally. Both policies improve the overall welfare of households, and the rebate policy especially benefits low-income households. In the long run, however, the debt accumulated to finance the stimulus and a higher tax to service the debt can crowd out capital and reduce output and consumption, causing welfare to deteriorate.

Keywords: Short-Run Fiscal Policy, Life-Cycle Model, General Equilibrium

JEL Classification: E2, E62, H24, H6