Fiscal reaction rules in numerical macro models

Richard L. Johnson

No RWP 01-01, Research Working Paper from Federal Reserve Bank of Kansas City

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.

Keywords: Fiscal policy; Debt (search for similar items in EconPapers)
Date: 2001
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