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This paper presents a capitalist-worker New Keynesian model for fiscal policy analysis that
incorporates insights from the recent heterogeneous agent, incomplete markets literature
while preserving the tractability of a two-agent framework. In the model, capitalists earn
income from firm profits and investing in physical capital, while workers only receive labor
income. Portfolio adjustment costs deliver realistic intertemporal marginal propensities to
consume, and the concentration of profit income among wealthy capitalists avoids implausible
income effects on labor supply. The embedded fiscal transmission mechanism implies that
deficit-financing is expansionary due to redistributive effects. We estimate a medium-scale
version of the model by Bayesian impulse response matching, drawing on a novel stylized
fact: the response of the labor share of income to an unanticipated increase in government
purchases is positive, persistent and hump-shaped. The model is able to replicate this
characteristic pattern and the dynamics of other key macroeconomic variables under a
plausible parameterization, suggesting that not only the presumed transmission mechanism
is better in line with micro evidence but also that the implied aggregate dynamics fit macro
data well.
