Aggregate Instability and Fiscal Policies: Balanced Budget Rules and Productive Public Spending

Hyun Park
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Hyun Park: Kyung Hee University

Korean Economic Review, 2015, vol. 31, 25-56

Abstract: This article revisits the aggregate stability property of fiscal policies with balanced budget rules using a standard one-sector growth model. As in Schmitt-Grohe and Uribe (1997) aggregate instability is driven by self-filling beliefs in the presence of multiple equilibrium paths. However, I find the existence of an indeterminate balanced growth path with a continuum of competitive equilibrium paths when productive public spending on aggregate production is endogenously financed by a predetermined rate of income taxes under balanced budget rules. In this economy, local and global in determinacy emerges when labor supply is highly elastic and a slope of aggregate (not necessarily individual) labor demand is positive by the productivity of public spending, independent of the usual indeterminacy conditions under fiscal policies such as types of distortionary taxes, sources of government revenue, composition of government expenditure, countercyclical taxation, and predetermined public spending.

Keywords: Balanced Budget Rules; Endogenous Labor Supply; Fiscal Increasing Returns; Indeterminacy; Productive Public Spending (search for similar items in EconPapers)
JEL-codes: E32 E62 H21 O41 (search for similar items in EconPapers)
Date: 2015
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