Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes

Abstract

It is known that in a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise due to endogenous labour income tax rates. This article shows that when the government finances its expenditures via an endogenous consumption tax instead, a steady state is always saddle-path stable. Consequently, combining income taxes with consumption taxes makes the ranges of indeterminacy shrink, thus reducing the possibility of aggregate instability. From a policy perspective, the results provide an additional argument in favour of consumption taxes in place of capital taxes. Copyright 2007 The Author(s). Journal compilation Royal Economic Society 2007.

Public Debt and Economic Growth in Uzawa’s Two-Sector Model With Public Goods

“…Lin's examination is focused on the effects of changes in some parameters on the steady state; while this study is focused on effects of changes in some parameters on the dynamic paths of the economic system as well as on the equilibrium point. Almost of all the recent theoretical literature of dynamic interactions between economic growth and public debts use either the Ramsey framework in continuous time (Cohen and Sachs, 1986;Blanchard and Fischer, 1989;Barro et al 1995;Semmler and Sieveking, 2000;Guo and Harrison, 2004;and Giannitsarou, 2007) or the OLG modeling framework in discrete time (Diamond, 1965;Farmer, 1986;Turnovsky and Sen, 1991;Azariadis, 1993;de la Croix and Michel, 2002;and Chalk, 2000). Different from the traditional approaches to household decision, this study uses Zhang's approach to household decision to re-examine the debt issues addressed by Diamond (1965).…”

Market distortions and local indeterminacy: A general approach

“…23 Hence, not only configurations (i) to (iv) are possible, but configurations (v) and (vi) may also emerge. These last two configurations require that α ΓL < α * ΓL as shown in (21). They are possible in the absence of distortions on Ω, whereas they never emerge without effects through Γ, since α *…”

“…20 In Grandmont et al (1998), the consequences of indeterminacy and bifurcations for the existence and properties of equilibria, in particular those exhibiting deterministic and stochastic expectations-driven cycles, are explored. 21 Indeterminacy requires D < 1. Since D is increasing with ε γ , D 1 (σ) < 1 is needed, which is equivalent to σ > σ H1 when D ′ 1 (σ) < 0 as in Table 1.…”

“…In Table 1, where D ′ 1 (σ) < 0, this critical lower bound is higher or equal to σ H 1 , because σ > σ H 1 is a necessary condition for indeterminacy. 21 In Table 2, where D ′ 1 (σ) > 0, although σ > σ H 1 is no longer a necessary condition for indeterminacy, indeterminacy also requires a lower bound for σ.…”

Public Debt and Aggregate Stability with Endogenous Growth and a State-Dependent Consumption Tax

“…Another possibility to avoid an indeterminate equilibrium path is to assume that it is the consumption tax that is adjusted in a way such that the government budget is balanced at each point in time, as demonstrated by Giannitsarou (2007). There, it is shown that the economy is always characterized by a unique saddle-point stable growth path.…”