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Balanced-budget rules and aggregate instability: The role of endogenous capital utilization

Kevin Huang (), Qinglai Meng () and Jianpo Xue ()
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Qinglai Meng: Oregon State University

No 17-00005, Vanderbilt University Department of Economics Working Papers from Vanderbilt University Department of Economics

Abstract: Schmitt-Grohe and Uribe (1997) demonstrate that a balanced-budget fiscal policy can induce aggregate instability unrelated to economic fundamentals. The empirical relevance of this result has been challenged by subsequent studies. In this paper we show, both analytically and numerically, that such extrinsic instability is an empirically robust plausibility associated with a balanced-budget rule once endogenous capital utilization is taken into consideration. This suggests that the design or operation of a balanced-budget fiscal policy must recognize that it may constitute a practical source of self-fulfilling prophecies and belief-driven fluctuations.

Keywords: Balanced-budget rules; Income taxes; Public debt; Capital utilization; Consumption taxes; Sunspots; Self-fulfilling expectations; Indeterminacy (search for similar items in EconPapers)
JEL-codes: E3 E6 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2017-03-13
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Journal Article: Balanced‐Budget Rules and Aggregate Instability: The Role of Endogenous Capital Utilization (2018) Downloads
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