Sectoral Composition of Government Spending, Distortionary Income Taxation, and Macroeconomic (In)stabilit
Jang-Ting Guo (),
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
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
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https://economics.ucr.edu/repec/ucr/wpaper/201702.pdf First version, 2017 (application/pdf)
Journal Article: Sectoral composition of government spending, distortionary income taxation, and macroeconomic (in)stability (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:ucr:wpaper:201702
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