Fiscal Policy, Increasing Returns, and Endogenous Fluctuations

Posted: 15 Jul 1999 Last revised: 18 Nov 2001

See all articles by Jang-Ting Guo

Jang-Ting Guo

University of California, Riverside (UCR) - Department of Economics; University of California, Riverside

Kevin J. Lansing

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Date Written: April 2, 2001

Abstract

This paper examines the quantitative implications of government fiscal policy in a discrete-time one-sector growth model with a productive externality that generates social increasing returns to scale. Starting from a laissez-faire economy that exhibits local indeterminacy, we show that the introduction of a constant capital tax or subsidy can lead to various forms of endogenous fluctuations, including stable 2-, 4-, 8-, and 10-cycles, quasi-periodic orbits, and chaos. In contrast, a constant labor tax or subsidy has no effect on the qualitative nature of the model's dynamics. We show that the use of local steady-state analysis to detect the presence of multiple equilibria in this class of models can be misleading. For a plausible range of capital tax rates, the log-linearized dynamical system exhibits saddle-point stability, suggesting a unique equilibrium, while the true nonlinear model exhibits global indeterminacy. This result implies that stabilization policies designed to suppress sunspot fluctuations near the steady state may not prevent sunspots, cycles, or chaos in regions away from the steady state. Overall, our results highlight the importance of using a model's nonlinear equilibrium conditions to fully investigate global dynamics.

Note: This is a revised version of the paper. The abstract for the original paper was submitted and published by SSRN in December 1996.

Keywords: Fiscal Policy, Business Cycles, Sunspots, Nonlinear Dynamics, Chaos.

JEL Classification: E32, E62, H21, O41

Suggested Citation

Guo, Jang-Ting and Lansing, Kevin J., Fiscal Policy, Increasing Returns and Endogenous Fluctuations (October 1996). Available at SSRN: https://ssrn.com/abstract=3596

Jang-Ting Guo

University of California, Riverside (UCR) - Department of Economics ( email )

3133 Sproul Hall
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University of California, Riverside ( email )

HOME PAGE: http://faculty.ucr.edu/~guojt/index.html

Kevin J. Lansing (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

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San Francisco, CA 94105
United States
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415-977-4031 (Fax)

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