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A New Design for Automatic Fiscal Policy

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  • Laurence S. Seidman
  • Kenneth A. Lewis

Abstract

We offer a new design for automatic fiscal policy that can strengthen its role as a complement to counter–cyclical monetary policy, and analyse it in the Fair macroeconometric model that has been estimated using quarterly data for the US economy. Our automatic fiscal policy consists of the triggering of a transfer (or income tax rebate) whenever real GDP is at least X% below normal, the amount of the transfer varying with the size of the GDP gap. The size of the transfer is set with the sole purpose of effectively combating a recession. By contrast, the magnitudes of current automatic stabilizers are unintended by–products of setting the ratio of tax revenue to GDP, the degree of progressivity of the tax system and the level of unemployment benefits. We generate a severe recession using historical data and simulate the impact of our automatic fiscal policy. We assume that the Federal Reserve adheres to a counter–cyclical monetary policy governed by the interest rate (Taylor) rule estimated from historical data. We find that the interest rate rule alone mitigates the severe recession only modestly, whereas our automatic fiscal policy (together with the interest rate rule) substantially reduces the severity of the recession while generating only a relatively small rise in the government debt/GDP ratio.

Suggested Citation

  • Laurence S. Seidman & Kenneth A. Lewis, 2002. "A New Design for Automatic Fiscal Policy," International Finance, Wiley Blackwell, vol. 5(2), pages 251-284.
    • Handle: RePEc:bla:intfin:v:5:y:2002:i:2:p:251-284
    DOI: 10.1111/1468-2362.00097
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    Cited by:

    1. Laurence S. Seidman & Kenneth A. Lewis, 2003. "Is a Tax Rebate an Effective Tool for Combating a Recession?: A Reply to Shapiro and Slemrod," Working Papers 03-15, University of Delaware, Department of Economics.
    2. Laurence S. Seidman & Kenneth A. Lewis, 2004. "Transfers Plus Open-Market Purchases: a Remedy for Recession," Working Papers 04-02, University of Delaware, Department of Economics.
    3. Laurence Seidman, 2006. "Learning About Bernanke," Challenge, Taylor & Francis Journals, vol. 49(5), pages 19-32.
    4. Lewis, Kenneth A. & Seidman, Laurence S., 2008. "Overcoming the zero interest-rate bound: A quantitative prescription," Journal of Policy Modeling, Elsevier, vol. 30(5), pages 751-760.
    5. Henrique S. Basso & James Costain, 2016. "Fiscal Delegation in a Monetary Union with Decentralized Public Spending," CESifo Economic Studies, CESifo Group, vol. 62(2), pages 256-288.
    6. Henrique S. Basso & James Costain, 2017. "Fiscal delegation in a monetary union: instrument assignment and stabilization properties," Working Papers 1710, Banco de España.
    7. Matthew D. Shapiro & Joel Slemrod, 2003. "Did the 2001 Tax Rebate Stimulate Spending? Evidence from Taxpayer Surveys," NBER Chapters, in: Tax Policy and the Economy, Volume 17, pages 83-110, National Bureau of Economic Research, Inc.
    8. Steven A. Symansky & Thomas Baunsgaard, 2009. "Automatic Fiscal Stabilizers," IMF Staff Position Notes 2009/23, International Monetary Fund.
    9. Kenneth Lewis & Laurence Seidman, 2005. " Can Fiscal Stimulus Overcome the Zero Interest-Rate Bound?: A Quantitative Assessment," Working Papers 05-19, University of Delaware, Department of Economics.
    10. Seidman, Laurence & Lewis, Kenneth, 2015. "Stimulus without debt in a severe recession," Journal of Policy Modeling, Elsevier, vol. 37(6), pages 945-960.
    11. Kenneth Lewis & Laurence Seidman, 2005. "A Tax Rebate in A Recession: Is It Safe and Effective?," Working Papers 05-20, University of Delaware, Department of Economics.

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