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Tax Policy and Stability in a Model with Sector-Specific Externalities

  • Jang-Ting Guo

    (University of California, Riverside)

  • Sharon G. Harrison

    (Barnard College, Columbia University)

We show that in a two-sector real business cycle model wtih sufficiently strong investment externalities, a regressive tax policy can stabilize the economy against fluctuations driven by agents' animal spirits. By contrast, this economy with a flat or progressive tax scheme (such as that in the U.S.) is more susceptible to indeterminacy and sunspot fluctuations. In the model with an aggregate constant returns-to-scale technology or a low investment externality, we show that a regressive tax policy can destablize the economy by causing belief-driven flucutations. Moreover, depending on the size of investment externalities and the slope parameter of the tax schedule, the economy exhibits various types of endogenous fluctuations, including Hopf or saddle-node bifurcations and stochastic sunspot equilibria. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1006/redy.2000.0105
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 4 (2001)
Issue (Month): 1 (January)
Pages: 75-89

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Handle: RePEc:red:issued:v:4:y:2001:i:1:p:75-89
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  1. Roger E.A. Farmer & Jang Ting Guo, 1992. "Real Business Cycles and the Animal Spirits Hypothesis," UCLA Economics Working Papers 680, UCLA Department of Economics.
  2. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  3. Shea, John, 1993. "Do Supply Curves Slope Up?," The Quarterly Journal of Economics, MIT Press, vol. 108(1), pages 1-32, February.
  4. Stephanie Schmitt-Grohe & Martin Uribe, 1995. "Balanced-budget rules, distortionary taxes, and aggregate instability," Finance and Economics Discussion Series 95-44, Board of Governors of the Federal Reserve System (U.S.).
  5. Jang-Ting Guo & Kevin J. Lansing, 1997. "Indeterminacy and stabilization policy," Working Paper 9708, Federal Reserve Bank of Cleveland.
  6. Benhabib, Jess & Farmer, Roger E. A., 1996. "Indeterminacy and sector-specific externalities," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 421-443, June.
  7. Weder, Mark, 1997. "Animal spirits, technology shocks and the business cycle," SFB 373 Discussion Papers 1997,61, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  8. Guo, Jang-Ting & Lansing, Kevin J., 2002. "Fiscal Policy, Increasing Returns, And Endogenous Fluctuations," Macroeconomic Dynamics, Cambridge University Press, vol. 6(05), pages 633-664, November.
  9. Benhabib, Jess & Farmer, Roger E.A., 1991. "Indeterminacy and Increasing Returns," Working Papers 91-59, C.V. Starr Center for Applied Economics, New York University.
  10. Bennett, R.L. & Farmer, R.E.A., 1999. "Indeterminacy with Non-Separable Utility," Economics Working Papers eco99/34, European University Institute.
  11. Harrison, Sharon G., 2001. "Indeterminacy in a model with sector-specific externalities," Journal of Economic Dynamics and Control, Elsevier, vol. 25(5), pages 747-764, May.
  12. Perli, Roberto, 1998. "Indeterminacy, home production, and the business cycle: A calibrated analysis," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 105-125, February.
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