Aggregate instability and fiscal policies: Balanced budget rules and productive public spending

This article revisits the aggregate stability property of fiscal policies with balanced budget rules using a standard one-sector growth model. As in Schmitt-Grohe and Uribe (1997) aggregate instability is driven by self-filling beliefs in the presence of multiple equilibrium paths. However, I find the existence of an indeterminate balanced growth path with a continuum of competitive equilibrium paths when productive public spending on aggregate production is endogenously financed by a predetermined rate of income taxes under balanced budget rules. In this economy, local and global indeterminacy emerges when labor supply is highly elastic and a slope of aggregate (not necessarily individual) labor demand is positive by the productivity of public spending, independent of the usual indeterminacy conditions under fiscal policies such as types of distortionary taxes, sources of government revenue, composition of government expenditure, countercyclical taxation, and predetermined public spending.