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Balanced‐Budget Rules and Aggregate Instability: The Role of Endogenous Capital Utilization

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  • KEVIN X.D. HUANG
  • QINGLAI MENG
  • JIANPO XUE

Abstract

It has long been demonstrated that in a closed economy a balanced‐budget fiscal policy can induce aggregate instability unrelated to economic fundamentals. The empirical relevance of this result has been challenged by many studies. In this paper, we show that such extrinsic instability associated with a balanced‐budget rule is a robust phenomenon in a similar closed‐economy setting enhanced with endogenous capital utilization. This suggests that the design or operation of a balanced‐budget fiscal policy should recognize that it may constitute a potential source of self‐fulfilling prophecies and belief‐driven fluctuations.

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  • Kevin X.D. Huang & Qinglai Meng & Jianpo Xue, 2018. "Balanced‐Budget Rules and Aggregate Instability: The Role of Endogenous Capital Utilization," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(8), pages 1669-1709, December.
    • Handle: RePEc:wly:jmoncb:v:50:y:2018:i:8:p:1669-1709
    DOI: 10.1111/jmcb.12572
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    Cited by:

    1. Kevin X.D. Huang & Qinglai Meng & Jianpo Xue, 2019. "Capital Income Taxation and Aggregate Instability," Vanderbilt University Department of Economics Working Papers 19-00007, Vanderbilt University Department of Economics.
    2. Xue, Jianpo & Yip, Chong K., 2018. "Home production, balanced-budget taxation and economic (in)stability," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 231-242.
    3. Kevin x.d. Huang & Qinglai Meng & Jianpo Xue, 2019. "Capital Income Taxation and Aggregate Instability," Vanderbilt University Department of Economics Working Papers 19-00007, Vanderbilt University Department of Economics.

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    More about this item

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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