This paper systematically examines the theoretical and quantitative interrelations between government spending and disposable income inequality in a tractable monopolistically competitive Ramsey macroeconomy. Upon an increase in government size, we analytically show that whether the long-run after-tax Gini coefficient rises or falls depends on the sign and magnitude of the wealth/capital inequality effect versus those of the adjusted-labor effect. Under (i) a mild level of productive public expenditure externalities and (ii) a sufficiently high intertemporal elasticity of consumption substitution, our calibrated model is able to generate qualitatively as well as quantitatively consistent income inequality effects of government spending vis-à-vis recent estimation results.

This paper systematically examines the interrelations between equilibrium indeterminacy, endogenous entry and exit of intermediate input firms, and increasing returns to specialization within two versions of a parsimonious one-sector monopolistically competitive RBC model. The technology for producing an intermediate good is postulated to display internal increasing returns to scale in our benchmark framework, whereas positive productive externalities are considered in the alternative setting. We analytically show that either formulation will exhibit belief-driven cyclical fluctuations provided the equilibrium wage-hours locus is positively sloped and steeper than the household’s labor supply curve. We also find that ceteris paribus our alternative macroeconomy is more susceptible to indeterminacy and sunspots than the baseline counterpart.

In the context of a prototypical New Keynesian model, this paper examines the theoretical interrelations between two tractable formulations of progressive taxation on labor income versus (i) the equilibrium degree of nominal-wage rigidity as well as (ii) the resulting volatilities of hours worked and output in response to a monetary shock. In sharp contrast to the traditional stabilization view, we analytically show that linearly progressive taxation always operates like an automatic destabilizer which leads to higher cyclical fluctuations within the macroeconomy. We also obtain the same business cycle destabilization result under continuously progressive taxation if the initial degree of tax progressivity is sufficiently low.

This paper examines an infinite-horizon model of nonlinear income taxation in which the probability that the government can commit is high, but not certain. In this “loose commitment” environment, we find that even a little uncertainty over whether the government can commit yields substantial effects on the optimal dynamic nonlinear income tax system. This result holds even though separating taxation remains optimal, as in the case of full commitment. Under an empirically plausible parameterization, our numerical simulations show that high-skilled individuals must be subsidized in the short run, despite the government's redistributive objective, unless the probability of commitment is higher than 98%. Loose commitment also reverses the short-run welfare effects of changes in most of the model's parameters, and yields some counterintuitive outcomes. For example, all individuals are worse off, rather than better off, in the short run when the proportion of high-skilled individuals in the economy increases.

This note analytically examines the interrelations between macroeconomic (in)stability and investment adjustment costs in a one-sector endogenously growing small–open economy representative-agent model. We show that under costly capital accumulation, the economy exhibits indeterminacy and sunspots if and only if the equilibrium wage–hours locus slopes upward and is steeper than the household's labor supply curve. By contrast, the economy without adjustment costs for capital investment always displays saddlepath stability and equilibrium uniqueness, regardless of the degree of increasing returns inaggregate production.

Multiple-equilibria macroeconomic models suggest that consumers' and investors' perceptions about the state of the economy may be important independent factors for business cycles. In this paper, we verify empirically the interrelations between waves of optimism and pessimism and subsequent economic fluctuations. We focus on the behavior of nonfundamental movements in the consumer sentiment index, as a proxy for consumers' sunspots, and in the business formation index, representing investors' animal spirits, around economic turning points. We find that bearish consumers and entrepreneurs were present before the onset of some U.S. economic downturns, sometimes even when the fundamentals were all very strong. In particular, our analysis shows that self-fulfilling pessimism may have played a nontrivial role in the 1969–1970, the 1973–1975, and the 1981–1982 recessions. The results are robust to a range of alternative linear and nonlinear specifications. Our evidence provides some empirical support for the role of nonfundamental rational expectations in economic fluctuations.

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, quasiperiodic 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, whereas 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.