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The effects of fiscal policy in a neoclassical growth model

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  • Michael Dotsey
  • Ching Sheng Mo

Abstract

This paper studies the effects of fiscal policies--depicted as stochastic changes in government spending and distortionary tax rates--when the government is constrained from using lump sum taxes for achieving intertemporal budget balance. The ratio of debt to gnp, therefore, has consequences for the future choices of government spending and distortionary taxation and hence affects real economic activity. Further modeling fiscal policy in this way generates results that differ substantially from those in standard stochastic models where lump sum taxes are used for budget balance. The modeling of fiscal policy presented here is also consistent with empirical evidence on U.S. fiscal policy.

Suggested Citation

  • Michael Dotsey & Ching Sheng Mo, 1994. "The effects of fiscal policy in a neoclassical growth model," Working Paper 94-03, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:94-03
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    File URL: http://www.richmondfed.org/publications/research/working_papers/1994/pdf/wp94-3.pdf
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    References listed on IDEAS

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    1. Barro, Robert J & Sahasakul, Chaipat, 1986. "Average Marginal Tax Rates from Social Security and the Individual Income Tax," The Journal of Business, University of Chicago Press, vol. 59(4), pages 555-566, October.
    2. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
    3. Becker, Robert A., 1985. "Capital income taxation and perfect foresight," Journal of Public Economics, Elsevier, vol. 26(2), pages 147-167, March.
    4. Aiyagari, S. Rao & Christiano, Lawrence J. & Eichenbaum, Martin, 1992. "The output, employment, and interest rate effects of government consumption," Journal of Monetary Economics, Elsevier, vol. 30(1), pages 73-86, October.
    5. Baxter, Marianne, 1991. "Approximating suboptimal dynamic equilibria : An Euler equation approach," Journal of Monetary Economics, Elsevier, vol. 28(2), pages 173-200, October.
    6. R. E. Hall, 1971. "The Dynamic Effects of Fiscal Policy in an Economy with Foresight," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 229-244.
    7. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-334, June.
    8. Henning Bohn, "undated". "On Testing Sustainability of Government Deficits in a Stochastic Environment," Rodney L. White Center for Financial Research Working Papers 19-91, Wharton School Rodney L. White Center for Financial Research.
    9. Abel, Andrew B., 1982. "Dynamic effects of permanent and temporary tax policies in a q model of investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 353-373.
    10. Danthine, Jean-Pierre & Donaldson, John B., 1985. "A note on the effects of capital income taxation on the dynamics of a competitive economy," Journal of Public Economics, Elsevier, vol. 28(2), pages 255-265, November.
    11. Wilbur John Coleman, 1989. "An algorithm to solve dynamic models," International Finance Discussion Papers 351, Board of Governors of the Federal Reserve System (U.S.).
    12. Dotsey, Michael, 1990. "The Economic Effects of Production Taxes in a Stochastic Growth Model," American Economic Review, American Economic Association, vol. 80(5), pages 1168-1182, December.
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    Cited by:

    1. Ludvigson, Sydney, 1996. "The macroeconomic effects of government debt in a stochastic growth model," Journal of Monetary Economics, Elsevier, vol. 38(1), pages 25-45, August.
    2. Kevin J. Lansing, 1994. "Optimal fiscal policy when public capital is productive: a business- cycle perspective," Working Paper 9406, Federal Reserve Bank of Cleveland.

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    Keywords

    Fiscal policy;

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