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Macroeconomic stability under balanced‐budget rules and no‐income‐effect preferences

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  • Jang‐Ting Guo
  • Yan Zhang

Abstract

It has been shown that under an additively separable preference formulation between consumption and hours worked, indeterminacy and sunspots may arise in a standard one‐sector or two‐sector real business cycle model when the labor tax rate is endogenously determined by a balanced‐budget rule with a pre‐specified constant level of government expenditures. Our analysis finds that this indeterminacy result will completely disappear within either setting if the period utility function is postulated to exhibit no income effect on the householdʼs demand for leisure. In particular, the modelʼs low‐tax steady state displays saddle‐path stability and equilibrium uniqueness; whereas the high‐tax steady state is either a source or a saddle point.

Suggested Citation

  • Jang‐Ting Guo & Yan Zhang, 2022. "Macroeconomic stability under balanced‐budget rules and no‐income‐effect preferences," Pacific Economic Review, Wiley Blackwell, vol. 27(1), pages 3-17, February.
    • Handle: RePEc:bla:pacecr:v:27:y:2022:i:1:p:3-17
    DOI: 10.1111/1468-0106.12359
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    More about this item

    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

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