Increasing Returns, Balanced-Budget Rules, and Aggregate Fluctuations

Maxime Menuet, Alexandru Minea and Patrick Villieu

Annals of Economics and Statistics, 2025, issue 160, 155-182

Abstract: This paper examines the conditions needed for equilibrium (in)determinacy in growth models characterized by perfect competition and a balanced-budget rule (BBR). Contrary to the literature that assumes zero public debt, we build an endogenous growth model with a generalized BBR authorizing a constant positive debt level. We show that the emergence of aggregate instability dramatically depends on the dynamics of the debt-to-GDP ratio and the strength of social labor externalities. If the labor demand is positively sloped and steeper than the labor supply, two reachable balanced-growth paths appear---a no growth trap, and a positive growth solution---that gives birth to both local and global indeterminacy, hence aggregate instability driven by self-fulfilling beliefs (sunspots). In addition, we show that a fiscal rule such that the tax rate strongly responds to public-debt increases can remove the no-growth trap, and secure positive long-run growth.

Keywords: Endogenous Growth; Indeterminacy; Balanced-Budget Rules. (search for similar items in EconPapers)
JEL-codes: E62 O41 (search for similar items in EconPapers)
Date: 2025
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Related works:
Working Paper: Increasing Returns, Balanced-Budget Rules, and Aggregate Fluctuations (2019)
Working Paper: Increasing Returns, Balanced-Budget Rules, and Aggregate Fluctuations (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:adr:anecst:y:2025:i:160:p:155-182

DOI: 10.2307/48857615

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