The macroeconomic effects of fiscal policy in a stochastically growing economy

- We investigate the growth effects of fiscal policy under uncertainty.
- The elasticity of substitution is important for the macroeconomic performance.
- A high (low) elasticity of substitution gives a high (low) welfare-maximizing tax.

This paper develops a stochastic model of endogenous growth with productive government expenditure. Herein, we specify the CES production function according to recent empirical evidence. The elasticity of substitution plays a key role in determining macroeconomic performance and the effectiveness of fiscal policy under uncertainty. Results demonstrate that a large elasticity of substitution provides a large expected growth rate and also large volatility of the growth rate. Regarding these effects, the growth-maximizing tax rate and welfare-maximizing tax rate under uncertainty are larger or smaller than those of deterministic economy according to the elasticity of substitution.