Business Cycle Dynamics of a New Keynesian Overlapping Generations Model with Progressive Income Taxation

and mean y¹. The productivity state x^j is equally spaced and ranges from -σ_y 1 to
σ_y1 . We discretize the state space by using ne = 2 values and normalize e^xj so that
Pn= 1 μ(j)exj = 1∙⁸ For ne = 2, we have μ(j) = 0∙5 for j = 1,2∙

3.6 Calibration of the Ramsey model

In this model we calibrate the tax function so that the marginal tax rate paid by the
representative household in the non-stochastic steady state equals the marginal tax rate
on the average US-income. The government’s tax revenues are transferred lump-sum to
the representative agent. Capital’s share is α = 0∙36 and δ equals 0∙019, as is the case
in the OLG model. The parameters that determine the properties of the productivity
shock and the money supply shock are the same as those used in the simulations of the
OLG model. The remaining parameters are set as follows: β , γ and η₀ are chosen so
that

• the annualized capital-output ratio is the same in both models (i.e., K/Y = 2∙1)

• the representative agent works n = 1/3 hours,

• the velocity of M1 is the same in both models (i.e., Y/(M/P) = 1∙5)

Table 1 summarizes our choice of parameters for both models.

Table 1

Parameterization of the OLG and the Ramsey model

⁸ The number of productivity states ne = 2 is already found to generate sufficient heterogeneity in
wealth and income.

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