Balanced-budget rules, distortionary taxes, and aggregate instability
AbstractA traditional argument against a balanced-budget fiscal policy rule is that it amplifies business cycles by stimulating aggregate demand during booms via tax cuts and higher public expenditures and by reducing demand during recessions through a corresponding fiscal contraction. This paper suggests an additional source of instability that may arise from this type of fiscal policy rule. It shows that, within the standard neoclassical growth model, a balanced-budget rule can make expectations of higher tax rates self-fulfilling if the fiscal authority relies heavily on changes in labor income taxes to eliminate short-run fiscal imbalances. Copyright 1997 by the University of Chicago.
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Bibliographic InfoPaper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 95-44.
Date of creation: 1995
Date of revision:
Other versions of this item:
- Schmitt-Grohe, Stephanie & Uribe, Martin, 1997. "Balanced-Budget Rules, Distortionary Taxes, and Aggregate Instability," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 976-1000, October.
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