Stephen McKnight

Can indeterminacy and self-fulfilling expectations help explain international business cycles?

We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling, belief-driven fluctuations (i.e., sunspot shocks) can help resolve the major puzzles of international business cycles. We find that a combination of productivity and sunspot shocks can account for the observed counter-cyclical behavior in international relative prices and quantities, while simultaneously generating volatilities that match the data. The indeterminacy model can also resolve the Backus-Smith puzzle without requiring a low value of the trade elasticity.

Are Consumption Taxes Preferable To Income Taxes For Preventing Macroeconomic Instability

This paper examines the local determinacy implications of using consumption taxes and in- come taxes to finance a balanced budget fiscal policy for a variety of popular monetary policy rules. It is shown using a New Keynesian framework that the severity of the indeterminacy problem that arises under each tax system depends not only on the specification of the interest- rate feedback rule, but also on the magnitude of the steady state tax rate, the steady state government debt-output ratio, and the degree of price stickiness. However, significant differ- ences in the determinacy criteria across the two tax systems are found to exist. The robustness of the results are assessed by extending the baseline model to include capital accumulation and the taxation of bond interest income. From a policy perspective, our results suggest that future shifts towards indirect taxation could have non-trivial implications for the setting of monetary policy under balanced-budget rules, in particular the ability of the Taylor principle to achieve determinacy.