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Fiscal reaction rules in numerical macro models

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  • Richard Johnson
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    Abstract

    To avoid exploding government debt, numerical macro models require ‘fiscal reaction rules’. Present rules impose arbitrary, backward-looking reaction of taxes to deviations of the debt ratio from a target. Arbitrary models may be poor guides to monetary policy. An optimising fiscal policy-maker would look forward, and maximise an objective function. A simple optimising model implies the future tax rate should be constant. I implement the constant-future-tax rule in the IMF’s MULTIMOD model. Simulations show model outcomes’ sensitivity to the choice of fiscal rule. A constant tax rate induces smoother and hence preferable consumption paths to MULTIMOD’s existing rule.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 01-01.

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    Date of creation: 2001
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    Handle: RePEc:fip:fedkrw:rwp01-01

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    Keywords: Fiscal policy ; Debt;

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    1. Laurence J. Kotlikoff, 1998. "The A-K Model: It's Past, Present, and Future," NBER Working Papers 6684, National Bureau of Economic Research, Inc.
    2. Werner Roeger & Jan in 't Veld, 1997. "QUEST II. A Multi-Country Business Cycle and Growth Model," European Economy - Economic Papers 123, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
    3. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
    4. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
    5. Gary S. Anderson, 2010. "A reliable and computationally efficient algorithm for imposing the saddle point property in dynamic models," Finance and Economics Discussion Series 2010-13, Board of Governors of the Federal Reserve System (U.S.).
    6. Frederico S. Finan & Robert Tetlow, 1999. "Optimal control of large, forward-looking models efficient solutions and two examples," Finance and Economics Discussion Series 1999-51, Board of Governors of the Federal Reserve System (U.S.).
    7. Kozicki, Sharon & Tinsley, P. A., 2001. "Term structure views of monetary policy under alternative models of agent expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 149-184, January.
    8. Hamid Faruqee & Douglas Laxton & Bart Turtelboom & Peter Isard & Eswar Prasad, 1998. "Multimod Mark III," IMF Occasional Papers 164, International Monetary Fund.
    9. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc.
    10. Andrew T. Levin & John H. Rogers & Ralph W. Tryon, 1997. "A guide to FRB/Global," International Finance Discussion Papers 588, Board of Governors of the Federal Reserve System (U.S.).
    11. Mitchell, Peter R. & Sault, Joanne E. & Wallis, Kenneth F., 2000. "Fiscal policy rules in macroeconomic models: principles and practice," Economic Modelling, Elsevier, vol. 17(2), pages 171-193, April.
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    Cited by:
    1. Margarida Duarte & Alexander L. Wolman, 2002. "Regional inflation in a currency union: fiscal policy vs. fundamentals," International Finance Discussion Papers 746, Board of Governors of the Federal Reserve System (U.S.).
    2. Jan Willem van den End, 2013. "A macroprudential approach to address liquidity risk with the Loan-to-Deposit ratio," DNB Working Papers 372, Netherlands Central Bank, Research Department.
    3. Markus Leibrecht & Martin Schneider, 2006. "AQM-06: The Macro economic Model of the OeNB," Working Papers 132, Oesterreichische Nationalbank (Austrian Central Bank).
    4. Duarte, Margarida & Wolman, Alexander L., 2008. "Fiscal policy and regional inflation in a currency union," Journal of International Economics, Elsevier, vol. 74(2), pages 384-401, March.

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