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Fiscal Policy, Increasing Returns, And Endogenous Fluctuations

  • Guo, Jang-Ting
  • Lansing, Kevin J.

We examine the quantitative implications of government fiscal policy in a discrete-time one-sector growth model with a productive externality that generates social increasing returns to scale. Starting from a laissez-faire economy that exhibits an indeterminate steady state (a sink), we show that the introduction of a constant capital tax or subsidy can lead to various forms of endogenous fluctuations, including stable 2-, 4-, 8-, and 10- cycles, quasi-periodic orbits, and chaos. In contrast, a constant labor tax or subsidy has no effect on the qualitative nature of the model's dynamics. We also show that the use of local steady-state analysis to detect the presence of multiple equilibria in this class of models can be misleading. For a plausible range of capital tax rates, the log-linearized dynamical system exhibits saddle-point stability (suggesting a unique equilibrium) while the true nonlinear model exhibits global indeterminancy. Finally, we explore the use of a state-contingent capital subsidy/tax scheme for stabilization purposes. We show that a local control policy designed using the log-linearized model can rule out sunspot equilibria near the steady state but may not prevent fluctuations arising from global indeterminacy. We proceed to use the nonlinear model to design a policy that can stabilize the economy against all forms of endogenous fluctuations and select a globally unique equilibrium.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 6 (2002)
Issue (Month): 05 (November)
Pages: 633-664

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Handle: RePEc:cup:macdyn:v:6:y:2002:i:05:p:633-664_01
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