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

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Author Info
Sharon Harrison () (Barnard College, Columbia University)
Jang-Ting Guo () (UC-Riverside)

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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.

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Publisher Info
Paper provided by Barnard College, Department of Economics in its series Working Papers with number 0701.

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Length: 17 pages
Date of creation: Jul 2006
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Handle: RePEc:brn:wpaper:0701

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Related research
Keywords: Public Expenditures; Balanced-Budget Rules; Indeterminacy; Business Cycles.;

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Find related papers by 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

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