Aggregate stability and balanced-budget rules

Ghilardi, Matteo and Rossi, Raffaele (2014) Aggregate stability and balanced-budget rules. Journal of Money, Credit and Banking, 46 (8). pp. 1787-1809. ISSN 0022-2879

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Abstract

It has been shown that under perfect competition and a Cobb-Douglas production function, a basic real business cycle model may exhibit indeterminacy and sunspot fluctuations when income tax rates are determined by a balanced-budget rule (BBR). This paper introduces in an otherwise standard real business cycle model a more general and data-coherent class of production functions, namely, a constant elasticity of substitution production function. We show that the degree of substitutability between production factors is a key ingredient to understanding the (de)stabilizing properties of a BBR. Then we calibrate the model consistently with the empirical evidence; that is, we set the elasticity of substitution between labor and capital below unity. We show that compared to the Cobb-Douglas case, the likelihood of indeterminacy under a BBR is greatly reduced in the U.S., the EU, and the UK.

Item Type:
Journal Article
Journal or Publication Title:
Journal of Money, Credit and Banking
Uncontrolled Keywords:
/dk/atira/pure/subjectarea/asjc/1400/1402
Subjects:
ID Code:
71060
Deposited By:
Deposited On:
01 Oct 2014 08:56
Refereed?:
Yes
Published?:
Published
Last Modified:
07 Oct 2020 03:16