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Stabilization policy and indeterminacy in a small open economy

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  • Zhang, Yan

Abstract

This paper studies the (de)stabilizing effects of income tax rules in a two-sector small open economy with production externalities. The paper shows that in the model with positive sector-specific externalities in the investment sector and negative sector-specific externalities in the consumption sector (or positive aggregate investment externalities), a regressive income tax rule can stabilize such an economy against indeterminacy, whereas a progressive income tax rule can increase the tendency for indeterminacy to occur. This paper also studies two variants that consider an imperfect world bond market and an endogenous labor supply, respectively, and shows that the qualitative results stated above remain valid. Moreover, increasing the level of sector-specific investment externalities can decrease (increase) the minimal level of tax progressivity required for indeterminacy if the investment externalities are below (above) a certain critical value and if the negative externalities in the consumption sector are taken as given.

Suggested Citation

  • Zhang, Yan, 2020. "Stabilization policy and indeterminacy in a small open economy," Economic Modelling, Elsevier, vol. 90(C), pages 159-167.
    • Handle: RePEc:eee:ecmode:v:90:y:2020:i:c:p:159-167
    DOI: 10.1016/j.econmod.2020.02.045
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    Cited by:

    1. Micheli, Martin, 2020. "Aggregate stability under a budget rule and labor mobility," Economic Modelling, Elsevier, vol. 93(C), pages 510-519.

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    More about this item

    Keywords

    Local indeterminacy; Small open economy; Tax progressivity;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation

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