The Macroeconomic Effects of Tax Shocks: The Cost Channel

Abstract

I develop a simple analytical New Keynesian model with a cost channel to gain new insights into the general properties of tax shocks. In this paper, I formally show that the cost channel itself can rule out the sunspot liquidity traps and secure a unique equilibrium with tax shocks. I also contribute to the tax-related literature that the absolute magnitudes of output gap and inflation multipliers due to a cost channel with/without the zero lower bound binding are heterogeneous compared with the standard model and the multipliers can be reproduced with a wide range of estimates. Finally, the multipliers are robust with the medium run tax cut policy except the consumption tax.