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Fiscal reaction rules in numerical macro models

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  • Richard L. Johnson

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.

Suggested Citation

  • Richard L. Johnson, 2001. "Fiscal reaction rules in numerical macro models," Research Working Paper RWP 01-01, Federal Reserve Bank of Kansas City.
    • Handle: RePEc:fip:fedkrw:rwp01-01
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    File URL: https://www.kansascityfed.org/documents/5419/pdf-RWP01-01.pdf
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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. Markus Leibrecht & Martin Schneider, 2006. "AQM-06: The Macro economic Model of the OeNB," Working Papers 132, Oesterreichische Nationalbank (Austrian Central Bank).
    3. 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.
    4. Jan Willem Van den End, 2016. "A macroprudential approach to address liquidity risk with the loan-to-deposit ratio," The European Journal of Finance, Taylor & Francis Journals, vol. 22(3), pages 237-253, February.

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    Keywords

    Fiscal policy; Debt;

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