NONSEPARABLE PREFERENCES DO NOT RULE OUT AGGREGATE INSTABILITY UNDER BALANCED BUDGET RULES: A NOTE
We investigate the role of nonseparable preferences in the occurrence of macroeconomic instability under a balanced budget rule where government spending is financed by a tax on labor income. Considering a one sector neoclassical growth model with a large class of nonseparable utility functions, we find that expectations driven fluctuations occur easily when consumption and labor are Edgeworth substitutes or weak Edgeworth complements. Under these assumptions, an intermediate range of tax rates and a sufficiently low elasticity of intertemporal substitution in consumption lead to instability.
Macroeconomic Dynamics