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Working Paper

Indeterminacy and Stabilization Policy

It has been shown that a one-sector real business cycle model with sufficient increasing returns in production may possess an indeterminate steady state that can be exploited to generate business cycles driven by "animal spirits" of agents. This note shows how an income tax schedule that exhibits a progressivity feature can ensure saddle path stability in such a framework and thereby stabilize the economy against sunspot fluctuations. Conversely, and economy that exhibits a flat or regressive tax schedule is more susceptible to indeterminacy.

Suggested Citation

Guo, Jang-Ting, and Kevin Lansing. 1997. “Indeterminacy and Stabilization Policy.” Federal Reserve Bank of Cleveland, Working Paper No. 97-08.