Is Japanese Prime Minister Shinzo Abe's "Abenomics" working?
It is too early to tell... The postponement of the consumption tax increase that was announced last week was a step back on the efforts to reduce the budget deficits, which is considered to be a part of the second arrow (flexible fiscal policy).
(a) Consider a tax reform policy that would replace the income tax system with a consumption tax. What does our model predict will be the macroeconomic effects of this shift, assuming that the consumption tax would raise exactly the same amount of revenue as the income tax it replaces.
In answering this question, assume that the policy shift is permanent and make the following assumptions:
(i) The policy is implemented today (in the current period).
(ii) The policy change is unanticipated (that is, not already incorporated into individual behaviors).
(iii) Households assume future as well as current tax rates are affected.
(iv) The expectations of all future variables, other than tax rates, remain fixed (our usual assumption).
(v) Labor supply is perfectly inelastic with respect to permanent changes in after-tax wages. (That is, any changes in current after-tax wages are completely offset by changes in future after-tax wages.)
If more than one outcome is possible, be sure to identify all of the possibilities
(b) Redo part (a) assuming that, in addition to the changes identified in the first part, the policy shift imposes a negative wealth shock on the current population. As before, identify all possibilities if more than one outcome is possible.
(c) Suppose that the intent of legislators is to expand future growth by inducing greater investment spending by businesses. Will the tax reform have the desired effects (according to your analysis)? If the answer is "it depends", be sure to identify the conditions under which the answer is "yes."
The Labor-Market Equilibrium and Production
1A: Determine if the exogenous shock changes the maximum amount of output that can be produced at any given level of N. (Does the production curve shift?)
1B: Determine if the exogenous shock changes the quantity of labor that firms want to hire at any given real wage. (Does the labor demand curve shift?)
1C: Determine if the exogenous shock changes the quantity of labor that households want to supply at any given real wage. (Does the labor supply curve shift?)
1D: From 1B and 1C determine the changes, if any, in the equilibrium real wage and equilibrium quantity of N.
1E: From 1A and 1D, determine the equilibrium quantity of Y.
The Goods-Market Equilibrium
2A: Determine if any change in the equilibrium quantity of Y or other direct effects of the exogenous shock affect the quantity that households desire to consume at any given real interest rate.
2B: Determine if the exogenous shock changes the quantity of government purchases of goods and services.
2C: Determine if the exogenous shock changes the quantity that firms desire to invest at any given real interest rate.
2D: Using 2A-2C, determine the changes, if any, in the equilibrium real interest rate and the equilibrium quantities of I and C.