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Increasing Returns, Balanced-Budget Rules, and Aggregate Fluctuations

Author

Listed:
  • Maxime Menuet
  • Alexandru Minea
  • Patrick Villieu

Abstract

This paper examines the conditions needed for equilibrium (in)determinacy in growth models characterized by perfect competition and a balanced-budget rule (BBR). Contrary to the literature that assumes zero public debt, we build an endogenous growth model with a generalized BBR authorizing a constant positive debt level. We show that the emergence of aggregate instability dramatically depends on the dynamics of the debt-to-GDP ratio and the strength of social labor externalities. If the labor demand is positively sloped and steeper than the labor supply, two reachable balanced-growth paths appear---a no growth trap, and a positive growth solution---that gives birth to both local and global indeterminacy, hence aggregate instability driven by self-fulfilling beliefs (sunspots). In addition, we show that a fiscal rule such that the tax rate strongly responds to public-debt increases can remove the no-growth trap, and secure positive long-run growth.

Suggested Citation

  • Maxime Menuet & Alexandru Minea & Patrick Villieu, 2025. "Increasing Returns, Balanced-Budget Rules, and Aggregate Fluctuations," Annals of Economics and Statistics, GENES, issue 160, pages 155-182.
    • Handle: RePEc:adr:anecst:y:2025:i:160:p:155-182
    DOI: 10.2307/48857615
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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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