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The fiscal multiplier with heterogeneous agents: the role of wealth, wealth distribution, and interest rates under Ricardian equivalence

Norman Sedgley, Charles Scott and Fred Derrick

Keywords: wealth distribution; fiscal policy; Ricardian equivalence

This paper looks at the relationship between the government fiscal multiplier and the distribution of wealth in a model with Ricardian equivalence. The output multiplier is derived. The approach taken allows for heterogeneity in agents’ utility functions. The intertemporal elasticity of substitution is allowed to vary with an agent's initial endowment of wealth. Multipliers are derived under simple monetary reaction rules. These cases describe how the effectiveness of fiscal policy might depend on the distribution of wealth in the economy. We find that an increase in wealth anywhere along the distribution of wealth increases the size of the fiscal multiplier under real interest rate targeting. Owing to changes in real interest rates under a less accommodative monetary policy an increase in wealth has an ambiguous effect under a strict inflation target or in a flexible price equilibrium. A redistribution of wealth always has an ambiguous effect which depends, in part, on the relative sensitivity of changes in consumption due to changes in expected future taxes when wealth varies for the losing versus the gaining quintile.

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