Luxury goods externalities, taxation and endogenous cycles

Abstract

This thesis aims to analyze aggregate instability due to volatile expectations in a simple OLG model with money. We assume there are two types of goods, necessity and luxury goods, from which agents take utility, with the particularity of having a consumption externality affecting the consumption of the latter. We also assume government to follow a balanced budget rule with public spendings financed exclusively through consumption taxation. Tax rates for each type of good may be different and may to react to the cycle. We verify that the distinction between necessity and luxury goods is not relevant for the emergence of indeterminacy, if there is no government intervention and if the externality has no influence. Then we show that the fiscal policies considered may create local indeterminacy, in the absence of externalities, if tax rates are strongly pro-cyclical or counter-cyclical. We also show that externalities, per se, may create indeterminacy. However, consumption taxation can, in fact, be a stabilizing instrument, by eliminating local indeterminacy, if one of the tax rates is set pro-cyclically (counter-cyclically) for a positive (negative) externality degree.