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2017 | OriginalPaper | Buchkapitel

5. Stabilization Effects of Policy Rules

verfasst von : Kazuo Mino

Erschienen in: Growth and Business Cycles with Equilibrium Indeterminacy

Verlag: Springer Japan

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Abstract

The stabilization effects of fiscal and monetary policy in the context of dynamic macroeconomic models with rational expectations differ from the effects in traditional Keynesian models. In the rational expectations setting, if a policy rule eliminates multiplicity of equilibrium, that policy stabilizes the economy in the sense that it excludes sunspot-driven business fluctuations. Conversely, if a policy rule gives rise to equilibrium indeterminacy, that policy destabilizes the economy. Roughly speaking, if a policy rule stabilizes a Keynesian model with backward-looking expectations, the same policy often generates indeterminacy in the equilibrium models with rational expectations.

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Vorheriges Kapitel Growth Models with Multiple Steady States

Nächstes Kapitel Indeterminacy in Open Economies

Giannitsarou (2007) also analyzes an alternative policy rule under which the government consumption is finacced by consumption tax as well as by income tax, thereby, the government budget constraint is

$$\displaystyle{ G =\tau _{c}C +\tau _{y}Y. }$$

Giannitsarou (2007) numerically shows that in this policy regime, indeterminacy may arise, but the parameter space generating indeterminacy is smaller than the case with labor-income taxation.

We should note that the above outcome depends on the assumption that the instantaneous utility function is additively separable between consumption and labor. Bambi and Venditti (2016) assume that the representative household has a general, non-separable utility function. They reveal that balancing the government budget by adjusting consumption tax may yield indeterminacy.

Hence, fiscal policy is “passive” in the sense of Leeper (1991).

As shown in Sect. 3.2, the restriction $\phi > -\left (1-\alpha \right )/\alpha$ ensures that the steady state level of consumption has a positive value.

No substantial change arises, if we use a more general CES utility function such that $u(C_{t}) = C_{t}^{1-\sigma }/\left (1-\sigma \right ),\ \ \sigma > 0$.

Note that the after-tax income is $\left (1 -\tau _{t}\right )Y _{t} = Y _{t} -\eta Y _{t}^{1-\phi }Y _{t}^{{\ast}\phi }$ and the after tax rate of return on private capital is given by $\left (1 -\tau _{t}\right )\alpha Y _{t}/K_{t} =\eta Y _{t}^{{\ast}\phi }A^{1-\phi }K_{t}^{\alpha \left (1-\phi \right )-1}\bar{K}_{t}^{\left (1-\alpha \right )\left (1-\phi:\right )}.$

When the model economy does not allow endogenous growth, the reference level of income Y ^∗ is the steady state level of Y _t, which is fixed. As a result, the rate of income tax $\tau _{t} = 1 -\eta \left (\frac{Y ^{{\ast}}} {Y _{t}} \right )^{\phi }$ increases $\left (\text{decreases}\right )$ if $\phi > 0\left (\phi < 0\right )$. Hence, an expansion of income caused by an optimistic sunspot shock raises the rate of income tax, under which the expectations generated by the sunspot shock will not be self-fulfilled, This stabilization effect of progressive tax may not hold in an endogenous growth environment where Y _t ^∗ is also affected by sunspots.

Meng and Yip (2004) used a neoclassical monetary growth model based on the money-in-the-utility function formulation. Yip and Li (2004), on the other hand, showed that if a cash-in-advance constraint applies to both investment and consumption so that money is not superneutral in the steady state, the interest-rate control rule may generate indeterminacy. See also Dupor (2001).

Indeterminacy may emerge if the model introduces labor-leisure choice. As pointed out by Meng and Yip (2004), this possibility, however, requires that the labor supply curve has a positive slope.

When the nominal interest rate responds to inflation alone in an Ak growth model, intermediacy would emerge either if labor supply is endogenous or if a cash-in-advance constraint applies to investment as well; see Itaya and Mino (2004, 2007) and Suen and Yip (2005). In these cases, money is not superneutral on the balanced-growth path, which is different from our present formulation in which monetary policy cannot affect long-term economic growth.

In our notation, Taylor’s principle is expressed as $R = 1.5\left (\pi -\pi ^{{\ast}}\right ) + 0.5y$ (or $R = 1.5\left (\pi -\pi ^{{\ast}}\right ) + 1.0y)$, where π ^∗ denotes the target rate of inflation.

Global indeterminacy emerges if (5.79) is satisfied for all $z \in \left (0,A\right )$, which imposes further restrictions on the $\phi \left (\pi \right )$ and $\eta \left (g\right )$ functions.

In this situation, the substitution effect of a change in the nominal interest rate dominates the income effect, which depresses the growth of consumption demand.

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Titel: Stabilization Effects of Policy Rules
verfasst von: Kazuo Mino
Verlag: Springer Japan
Buch: Growth and Business Cycles with Equilibrium Indeterminacy
Print ISBN: 978-4-431-55608-4

Electronic ISBN: 978-4-431-55609-1

Copyright-Jahr: 2017
DOI: https://doi.org/10.1007/978-4-431-55609-1_5