Alternative Specifications of Intertemporal Fiscal Policy in a Small Theoretical Model

In this second of a series of three working papers, we use a simple neoclassical growth model to illustrate how consumption, investment, and output—more broadly, the entire dynamic equation system of a model—can be strongly influenced by alternative specifications of a reaction function describing the intertemporal behavior of a government's fiscal authority. The classes of fiscal rule studied—debt-stock targeting, incremental interest payments (IIP), and the analytical benchmark of a balanced budget—are described and discussed in the first paper in the series. The analysis demonstrates that the consequences of shocks or policy actions can be strongly conditioned by the intertemporal fiscal reaction function imposed on a macroeconomic model. Significant variation can occur for different types of rule, for alternative assumptions about the timing of the rule's activation, and for alternative values of the rule's feedback coefficients.