Indeterminacy and Government Spending in a Two-Sector Model of Endogenous Growth

Abstract

This paper analyzes the dynamic behavior of a two-sector model of endogenous growth with unproductive government spending. In this model, we prove that the subspace of the parameter space where the equilibrium exhibits indeterminacy is larger, the larger the fraction of government revenues devoted to government expenditures is, the more patient consumers are, and the more consumers are willing to substitute consumption intertemporally. Our analysis shows that, with the introduction of unproductive government spending, indeterminacy becomes a plausible property of the dynamic equilibrium in a two-sector growth model with factor taxes as the only market imperfection. We also show that, when the fraction of government revenues devoted to government expenditures is large, plausible fiscal policies may cause the equilibrium to exhibit indeterminacy. Journal of Economic Literature Classification Numbers: E62, O41, H31.