Working Paper

Fiscal reaction rules in numerical macro models

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.

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2001

Number: RWP 01-01