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Sectoral composition of government spending, distortionary income taxation, and macroeconomic (in)stability. (English) Zbl 1422.91519

Int. J. Econ. Theory 15, No. 1, 95-107 (2019); erratum ibid. 17, No. 4, 479 (2021).
Summary: This paper examines the interrelations between the sectoral composition of government spending and macroeconomic (in)stability in a two-sector real business cycle model with positive productive externalities in investment and a balanced-budget fiscal policy rule, whereby endogenous public expenditures are financed by the distortionary constant tax rate. Under the benchmark parameterization, our model always exhibits indeterminacy and sunspots provided the tax rate does not exceed a critical value. When the tax rate is raised to a higher level, a sufficiently high public-consumption share can destabilize the macroeconomy by generating belief-driven cyclical fluctuations. We also find that saddle-path stability and equilibrium uniqueness will prevail when the household’s labor supply elasticity is not higher than a threshold level. In addition, analytical proofs for each of the aforementioned quantitative results are provided.

MSC:

91B64 Macroeconomic theory (monetary models, models of taxation)
91B66 Multisectoral models in economics
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References:

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