Useful Government Spending and Macroeconomic (In)stability under Balanced-Budget Rules∗
نویسندگان
چکیده
It has been shown that an otherwise standard one-sector real business cycle model may exhibit indeterminacy and sunspots under a balanced-budget rule that consists of fixed and wasteful government spending and proportional income taxation. However, the economy always displays saddle-path stability and equilibrium uniqueness if the government finances endogenous public expenditures with a constant income tax rate. In this paper, we allow for productive or utility-generating government purchases in either of these specifications. It turns out that when public expenditures are pre-set, the existing indeterminacy results are not affected, regardless of how useful government spending is introduced to the model. On the contrary, under a fixed income tax rate, the previous determinacy results are reversed when government purchases generate sufficiently strong production or consumption externalities. In each case, we derive the necessary and sufficient condition on the minimum degree of public-spending externality needed for producing indeterminacy and sunspots. Our analysis thus illustrates that a balanced-budget policy recommendation which limits the government’s ability to change tax rates does not necessarily stabilize the economy against belief-driven business cycle fluctuations.
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Balanced-budget rules and macroeconomic (in)stability
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