Intertemporal Fiscal Policy in Macroeconomic Models: Introduction and Major Alternatives

The research reported in this set of three working papers focuses on different assumptions about the intertemporal behavior of government policymakers. In particular, we carefully study alternative specifications of intertemporal fiscal closure rules and their impacts on the effectiveness of macroeconomic policies. In this first paper, we introduce the subject, make general observations about policy reaction functions, and then identify the main possibilities for intertemporal fiscal closure rules. We concentrate on the alternative types of fiscal rule that have so far been introduced into existing empirical macroeconomic models. The second paper in the series uses a small growth model to study the theoretical implications of these intertemporal rules. A third paper describes a two-region empirical macroeconomic model based on the equations for the United States in the IMF staff's multicountry model, MULTIMOD, and reports simulation results of the alternative fiscal closure rules implemented in that abridgement of MULTIMOD. The research highlights the conclusion that, in a macroeconomic model of any type, the consequences for national economies of a shock or policy action can be significantly conditioned by the intertemporal fiscal reaction function used in the model. The point applies to all time horizons—the short and medium runs as well as the long-run steady state. Builders and users of macroeconomic models thus need to pay more careful attention to fiscal reaction functions than they typically have in the past.

Abstract