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

Abstract

We analyze how different budgetary rules affect the stability of an economy in a basic endogenous growth model with public debt and a state-dependent consumption tax rate. We show that a discretionary policy implies that the government violates its inter-temporal budget constraint along a balanced growth path, whereas a balanced budget rule guarantees that the economy is stable. A rule based debt policy gives rise to stability if the reaction of the primary surplus to higher public debt is sufficiently large. Further, in case of a strongly regressive consumption tax rate over a certain range, multiple balanced growth paths may emerge. The main results can be generalized to hold for any endogenous growth model with infinitely lived households.JEL: C62, H63, O41

Aggregate stability under a budget rule and labor mobility

“…Such a rule can result in aggregate instability for empirically plausible parameter constellations. Many subsequent studies show that aggregate stability in models with balanced-budget rules depends on whether the government adjusts the budget via the income or via expenditures ( Guo and Harrison, 2004 ), the supply of public goods ( Palivos et al, 2003 ), the tax type ( Giannitsarou, 2007 ), the utility function ( Nourry et al, 2013 ), and the production function ( Nishimura et al, 2013 ; Ghilardi and Rossi, 2014 ; Greiner and Bondarev, 2015 ). In a small open economy, indeterminacy is less of an issue due to integration in international capital and goods markets ( Meng and Xue, 2015 ; Huang et al, 2017 ).…”