Aggregate Stability and Balanced-Budget Rules Prepared by Matteo F. Ghilardi and Raffaele Rossi * * We would like to thank Pok-sang Lam and two anonymous referees for their insightful comments.
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.JEL codes: E32, E62
This paper develops an open-economy DSGE model with an optimizing banking sector to assess the role of capital flows, macro-financial linkages, and macroprudential policies. The key result is that macroprudential measures can usefully complement monetary policy. Countercyclical macroprudential polices can help reduce macroeconomic volatility and enhance welfare. The results also demonstrate the importance of capital flows and financial stability for business cycle fluctuations as well as the role of supply side financial accelerator effects in the amplification and propagation of shocks.
This paper analyzes the tradeoffs between savings, debt and public investment in the Republic of Congo, a developing country with looming oil exhaustibility concerns. Our results highlight the risks to fiscal and capital sustainability of oil exporting countries from large scaling-up in public investment and oil price volatility in view of a projected decline in the oil revenue to GDP ratio. However, structural reforms that improve the efficiency of public investment can allow for a relatively faster buildup of sustainable public capital and sustain higher non-oil growth without adversely affecting the debt ratio or savings. Moreover, we show that even if a government pursues prudent fiscal policy that preserves resource wealth and debt sustainability in the face of exhaustible and volatile resource revenues, low public investment quality in the form of a misallocation of resources can hinder attainment of sustainable public capital and positive non-oil growth.
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