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Kevin x.d. Huang, Qinglai Meng and Jianpo Xue
''Balanced-budget rules and aggregate instability: The role of endogenous capital utilization''
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
JEL: E3 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data)
E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General
Manuscript Received : Mar 06 2017 Manuscript Accepted : Mar 13 2017

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