Balanced-Budget Rules, Distortionary Taxes, and Aggregate Instability

Stephanie Schmitt-Grohe and Martín Uribe ()

Journal of Political Economy, 1997, vol. 105, issue 5, 976-1000

Abstract: A traditional argument against a balanced-budget fiscal policy rule is that it amplifies business cycles by stimulating aggregate demand during booms via tax cuts and higher public expenditures and by reducing demand during recessions through a corresponding fiscal contraction. This paper suggests an additional source of instability that may arise from this type of fiscal policy rule. It shows that, within the standard neoclassical growth model, a balanced-budget rule can make expectations of higher tax rates self-fulfilling if the fiscal authority relies heavily on changes in labor income taxes to eliminate short-run fiscal imbalances. Copyright 1997 by the University of Chicago.

Date: 1997
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Working Paper: Balanced-budget rules, distortionary taxes, and aggregate instability (1995)
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Persistent link: https://EconPapers.repec.org/RePEc:ucp:jpolec:v:105:y:1997:i:5:p:976-1000

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