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Useful Government Spending and Macroeconomic (In)stability under Balanced-Budget Rules

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  • JANG-TING GUO
  • SHARON G. HARRISON

Abstract

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 the previous indeterminacy results remain unchanged by the inclusion of useful government spending. By contrast, the earlier determinacy results are overturned when public expenditures generate sufficiently strong production or consumption externalities. 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. Copyright � 2008 Blackwell Publishing, Inc..

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Bibliographic Info

Article provided by Association for Public Economic Theory in its journal Journal of Public Economic Theory.

Volume (Year): 10 (2008)
Issue (Month): 3 (06)
Pages: 383-397

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Handle: RePEc:bla:jpbect:v:10:y:2008:i:3:p:383-397

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Cited by:
  1. Mohanad Ismael, 2010. "Progressive income taxes and macroeconomic instability," Documents de recherche 10-13, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
  2. Noritaka Maebayashi & Takeo Hori & Koichi Futagami, 2012. "Dynamic analysis of reductions in public debt in an endogenous growth model with public capital," Discussion Papers in Economics and Business 12-08-Rev, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP), revised Feb 2013.
  3. Jang-Ting Guo & Shu-Hua Chen, 2010. "Progressive Taxation and Macroeconomic (In)stability with Productive Government Spending," Working Papers 201006, University of California at Riverside, Department of Economics, revised Aug 2010.
  4. Kunihiko Konishi, 2013. "Public Research Spending in an Endogenous Growth Model," Discussion Papers in Economics and Business 13-26, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  5. Xin Long & Alessandra Pelloni, 2012. "Welfare Improving Taxation on Savings in a Growth Model," Working Paper Series 01_12, The Rimini Centre for Economic Analysis.
  6. Lloyd-Braga, Teresa & Modesto, Leonor, 2012. "Can Taxes Stabilize the Economy in the Presence of Consumption Externalities?," IZA Discussion Papers 6876, Institute for the Study of Labor (IZA).
  7. Kazuo Nishimura & Carine Nourry & Thomas Seegmuller & Alain Venditti, 2013. "Public Spending as a Source of Endogenous Business Cycles in a Ramsey Model with Many Agents," AMSE Working Papers 1314, Aix-Marseille School of Economics, Marseille, France, revised 08 Feb 2013.
  8. Keiichi Morimoto & Takeo Hori & Noritaka Maebayashi & Koichi Futagami, 2013. "Fiscal Sustainability, Macroeconomic Stability, and Welfare under Fiscal Discipline in a Small Open Economy," Discussion Papers in Economics and Business 13-07, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  9. Takeo Hori & Noritaka Maebayashi, 2013. "Indeterminacy and utility-generating government spending under balanced-budget fiscal policies," Discussion Papers in Economics and Business 13-13, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  10. Kamiguchi, Akira & Tamai, Toshiki, 2011. "Can productive government spending be a source of equilibrium indeterminacy?," Economic Modelling, Elsevier, vol. 28(3), pages 1335-1340, May.
  11. Kazuo Nishimura & Carine Nourry & Thomas Seegmuller & Alain Venditti, 2014. "On the (de)Stabilizing Effect of Public Debt In a Ramsey Model with Heterogeneous Agents," Discussion Paper Series DP2014-03, Research Institute for Economics & Business Administration, Kobe University.

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