Macroeconomic stability under balanced‐budget rules and no‐income‐effect preferences

Jang-Ting Guo and Yan Zhang

Pacific Economic Review, 2022, vol. 27, issue 1, 3-17

Abstract: It has been shown that under an additively separable preference formulation between consumption and hours worked, indeterminacy and sunspots may arise in a standard one‐sector or two‐sector real business cycle model when the labor tax rate is endogenously determined by a balanced‐budget rule with a pre‐specified constant level of government expenditures. Our analysis finds that this indeterminacy result will completely disappear within either setting if the period utility function is postulated to exhibit no income effect on the householdʼs demand for leisure. In particular, the modelʼs low‐tax steady state displays saddle‐path stability and equilibrium uniqueness; whereas the high‐tax steady state is either a source or a saddle point.

Date: 2022
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