Aggregate Stability and Balanced-Budget Rules

February 10, 2014

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Format: Chicago

Matteo Ghilardi, and Raffaele Rossi. Aggregate Stability and Balanced-Budget Rules, (USA: International Monetary Fund, 2014) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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. 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 understand the (de)stabilising properties of a balanced-budget rule. Then we calibrate the model consistently with the empirical evidence, i.e. we set the elasticity of substitution between labour and capital below unity. We show that compared to the Cobb-Douglas case, the likelihood of indeterminacy under a balanced-budget rule is greatly reduced in the United States, the European Union and the United Kingdom.

Subject: Budget planning and preparation, Income tax systems, Labor, Public financial management (PFM), Taxes

Keywords: Budget planning and preparation, Business Cycles, Capital tax, Constant Elasticity of Substitution, Demand function, Demand schedule, Depreciation rate, Elasticity of substitution, Fiscal policy, Government budget constraint, Income share, Income tax systems, Indeterminacy, Labour income tax, Laffer curve, Production function, Substitution elasticity, WP

Publication Details

Pages:

26
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/023
Stock No:

WPIEA2014023
ISBN:

9781475582291
ISSN:

1018-5941

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