Two essays on indeterminacy, externalities and growth

Abstract

This thesis contains two essays. The first essay a??Trade Can Remove Indeterminacya?? is borne out of the fact that recent works on dynamic indeterminacy are largely based on the autarkic or the small-open economy framework. With this observation in mind, the essay is motivated by the following question: if indeterminacy exists in a country under autarky, can trade with another whose equilibrium path is unique result in uniqueness for all? To facilitate our analysis, I study a two-country dynamic trade model where prior to trade, indeterminacy exists in one country and saddle-path stability in the other. By introducing trade in final goods only, I find that saddle-path stability can prevail in both countries if the relative consumption of the a??saddle-patha?? country is sufficiently large. I also show numerically that this sufficient condition for uniqueness can be very easily satisfied. Therefore, although indeterminacy may appear under theoretical and empirical examinations of autarkic or small open-economy models, the steady states in actual fact could be saddle-path stable instead since trade takes place in most countries. In the second essay a??Indeterminacy, Stabilization Policy and Returns to Scalea??, I examine the effectiveness of taxation as a stabilization tool in the Benhabib and Farmer (1996) two-sector model with increasing returns and the Benhabib and Nishimura (1998) two-sector model with social constant returns where consumption and investment goods are distinct. This study has previously been carried out using the Benhabib and Farmer (1994) one-sector model with increasing returns by Guo and Lansing (1998) and Guo (1999). However, the one-sector Benhabib-Farmer framework has since been criticized for requiring implausibly large returns to scale to generate indeterminacy. For the two-sector Benhabib-Farmer model, I find that labor income taxation schedules of both flat and progressive are highly effective and more effective than capital income taxation schedules in eliminating indeterminacy in the model. However, for the Benhabib-Nishimura model with social constant returns to scale, I find that both labor and capital income taxation schedules at all progressivity levels are ineffective in removing sunspot fluctuations. I argue that this difference occurs as a result of the distinct mechanism in generating indeterminacy in the two models. In the two-sector Benhabib-Farmer model, a convex social production possibility frontier, combined with the endogeneity in labor supply decision, is necessary for indeterminacy while the necessary condition for indeterminacy in the Benhabib-Nishimura model is caused by private and social factor-intensity rankings that are the inverse of the other.