Tax Cuts, Employment and Asset Prices: A Real Intertemporal Model

We determine the effects of a delayed or immediate tax cut with or without a “sunset” feature in a real customer-market, nonRicardian economy. Our model incorporates both the supply-sider channel as well as the Feldstein-Rubin-Summers channel. We show that a tax cut may depress both the real asset price and employment. The presence of the paradoxical result of employment contraction does not work through nor imply an immediate increase of the long real interest rate, contrary to financial commentators. A similar analysis applies to the huge pension problem burdening several continental European economies so part of their high unemployment of late may be ascribed to their looming pension outlays. (JEL: E24, E43, E62, F41) ∗We thank Lawrence Summers for encouragement and useful comments. †Corresponding Author: Associate Professor Hian Teck Hoon, School of Economics and Social Sciences, Singapore Management University, 469, Bukit Timah Road, Singapore 259756. E-mail: [email protected]; tel: (65)-6822-0248; fax: (65)-6822-0833. ‡Professor Edmund S. Phelps, Department of Economics, Columbia University.