It has been shown that under perfect competition and a Cobb-Douglas
production function, a basic real business cycle model may exhibit
indeterminacy and sunspot fluctuations when income tax rates are
determined by a balanced-budget rule. This paper introduces in an
otherwise standard real business cycle model a more general and
data coherent class of production functions, namely a constant
elasticity of substitution production function. We show that the
degree of substitutability between production factors is a key
ingredient to understand the (de)stabilising properties of a
balanced-budget rule. Then we calibrate the model consistently with
the empirical evidence, i.e. we set the elasticity of substitution
between labour and capital below unity. We show that compared to
the Cobb-Douglas case, the likelihood of indeterminacy under a
balanced-budget rule is greatly reduced in the United States, the
European Union and the United Kingdom.
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