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NEWS ABOUT TAXES AND EXPECTATIONS-DRIVEN BUSINESS CYCLES

This paper analyzes the possibility of expectations-driven business cycles to emerge in a one-sector real business cycle model if the unique driving force is news about future income tax rates. We find that good news about labor income tax rates cannot generate expectations-driven business cycles, whereas good news about capital income tax rates can. We show that a one-sector real business cycle model enriched with (i) variable capital utilization and (ii) investment adjustment costs and driven solely by news shocks about capital income tax rates is able to generate qualitatively and quantitatively realistic business cycle fluctuations. In contrast to numerous studies in the news-driven business cycle literature, our model maintains separable preferences.