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Externalities, income taxes and indeterminacy in OLG models

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  • Chen, Yan
  • Zhang, Yan

Abstract

Using an aggregate two-periods overlapping generations model with endogenous labor, consumption in both periods of life, homothetic preferences and productive external effects [Lloyd-Braga et al., 2007. Indeterminacy in dynamic models: When Diamond meets Ramsey. Journal of Economic Theory 134, 513-536], we examine the effects of alternative government financing methods on the range of values of increasing returns leading to indeterminacy. We show that under a large enough share of first period consumption over the wage income, local indeterminacy can easily occur for mild externalities if constant government expenditure is financed through either labor or capital income taxes. More precisely, we show that, with labor income taxes and mild externalities, small government expenditures are helpful to local indeterminacy, while large government expenditures are useful to stabilize the economy. With capital income taxes and mild externalities, local indeterminacy always exists. Moreover, we explore how our previous results are changed once government expenditure is endogenously determined for fixed rates on labor and capital income under the balanced-budget rule.

Suggested Citation

  • Chen, Yan & Zhang, Yan, 2010. "Externalities, income taxes and indeterminacy in OLG models," MPRA Paper 22370, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:22370
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    File URL: https://mpra.ub.uni-muenchen.de/22370/1/MPRA_paper_22370.pdf
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    References listed on IDEAS

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    1. Zhang, Yan & Chen, Yan, 2009. "Endogenous income taxes and indeterminacy in dynamic models: When Diamond meets Ramsey again," MPRA Paper 17605, University Library of Munich, Germany.
    2. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
    3. Benhabib, Jess & Farmer, Roger E. A., 1996. "Indeterminacy and sector-specific externalities," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 421-443, June.
    4. Guo, Jang-Ting & Lansing, Kevin J., 2002. "Fiscal Policy, Increasing Returns, And Endogenous Fluctuations," Macroeconomic Dynamics, Cambridge University Press, pages 633-664.
    5. Reichlin, Pietro, 1986. "Equilibrium cycles in an overlapping generations economy with production," Journal of Economic Theory, Elsevier, vol. 40(1), pages 89-102, October.
    6. Lloyd-Braga, Teresa & Nourry, Carine & Venditti, Alain, 2007. "Indeterminacy in dynamic models: When Diamond meets Ramsey," Journal of Economic Theory, Elsevier, vol. 134(1), pages 513-536, May.
    7. Cazzavillan, Guido, 2001. "Indeterminacy and Endogenous Fluctuations with Arbitrarily Small Externalities," Journal of Economic Theory, Elsevier, vol. 101(1), pages 133-157, November.
    8. Schmitt-Grohe, Stephanie & Uribe, Martin, 1997. "Balanced-Budget Rules, Distortionary Taxes, and Aggregate Instability," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 976-1000, October.
    9. Guido Cazzavillan & Patrick A. Pintus, 2004. "Robustness of Multiple Equilibria in OLG Economies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(2), pages 456-475, April.
    10. Patrick Pintus, 2006. "Indeterminacy with almost constant returns to scale: capital-labor substitution matters," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(3), pages 633-649, August.
    11. Cazzavillan, Guido & Pintus, Patrick A., 2006. "Capital externalities in OLG economies," Journal of Economic Dynamics and Control, Elsevier, vol. 30(7), pages 1215-1231, July.
    12. Zhang, Yan & Chen, Yan, 2009. "Endogenous income taxes in OLG economies," MPRA Paper 16412, University Library of Munich, Germany.
    13. Gokan, Yoichi, 2008. "Alternative government financing and aggregate fluctuations driven by self-fulfilling expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1650-1679, May.
    14. Wen, Yi, 1998. "Capacity Utilization under Increasing Returns to Scale," Journal of Economic Theory, Elsevier, vol. 81(1), pages 7-36, July.
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    More about this item

    Keywords

    Indeterminacy; Endogenous income tax rates; Externalities.;

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium

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