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Should Dynamic Scoring be done with Heterogeneous Agent-Based Models? Challenging the Conventional Wisdom

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  • M Saifur Rahman

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    (Indiana University Bloomington)

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    Abstract

    Traditionally, Dynamic Scoring calculations experiments are carried out using representative agent based macroeconomic models. Existing literature does not provide any objection to this approach. In this paper, I develop a heterogeneous agent model similar to the Saver-Spenders model of Mankiw (2000). But spenders in my model are merely credit constrained and not rule-of-thumb consumers. Both groups are intertemporal optimizers because of the existence of Internal Habit Persistence. Transition path of most of the macro and fiscal variables for various tax cuts under alternative financing scheme shows pattern which are significantly different and sometimes contrasting to the representative agent model. Dynamic scoring calculations reveal a downward bias of the representative agent model. Underestimation of the dynamic response could be as large as 45%. Finally, steady state results indicate smaller impact of contractionary policies on major fiscal variables such as net tax revenue and tax base. Over all, the paper argues that the need to use heterogeneous agent based model in dynamic fiscal calculations is not only desirable, but also essential.

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    Bibliographic Info

    Paper provided by Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington in its series Caepr Working Papers with number 2008-023.

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    Length: 47 pages
    Date of creation: Sep 2008
    Date of revision:
    Handle: RePEc:inu:caeprp:2008-023

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