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Sectoral Composition of Government Spending, Distortionary Income Taxation, and Macroeconomic (In)stabilit

Jang-Ting Guo (), Juin-jen Chang, Jhy-Yuan Shieh () and Wei-Neng Wang ()
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Jhy-Yuan Shieh: Soochow University
Wei-Neng Wang: Academia Sinica

No 201702, Working Papers from University of California at Riverside, Department of Economics

Abstract: This paper quantitatively examines the interrelations between sectoral composition of government spending and macroeconomic (in)stability in a two-sector real business cycle model with positive productive externalities in investment and distortionary income taxation through a stylized balanced-budget fiscal policy rule. We find that under endogenous public expenditures, the benchmark model always exhibits indeterminacy and sunspots provided the constant 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 under the baseline parameterization with fixed government spending, the low-tax steady state is an indeterminate sink and the high-tax steady state is a saddle point, regardless of how public expenditures are divided between consumption and investment goods.

Keywords: Government Spending; Distortionary Income Taxation; Equilibrium (In)determinacy. (search for similar items in EconPapers)
JEL-codes: E32 E62 O41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
Date: 2017-02
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Journal Article: Sectoral composition of government spending, distortionary income taxation, and macroeconomic (in)stability (2019) Downloads
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