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A New Design for Automatic Fiscal Policy
Author(s) -
Seidman Laurence S.,
Lewis Kenneth A.
Publication year - 2002
Publication title -
international finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.458
H-Index - 39
eISSN - 1468-2362
pISSN - 1367-0271
DOI - 10.1111/1468-2362.00097
Subject(s) - economics , recession , fiscal policy , monetary economics , monetary policy , interest rate , unemployment , macroeconomics , taylor rule , real gross domestic product , tax revenue , output gap , debt , central bank
We offer a new design for automatic fiscal policy that can strengthen its role as a complement to counter–cyclical monetary policy, and analyse it in the Fair macroeconometric model that has been estimated using quarterly data for the US economy. Our automatic fiscal policy consists of the triggering of a transfer (or income tax rebate) whenever real GDP is at least X% below normal, the amount of the transfer varying with the size of the GDP gap. The size of the transfer is set with the sole purpose of effectively combating a recession. By contrast, the magnitudes of current automatic stabilizers are unintended by–products of setting the ratio of tax revenue to GDP, the degree of progressivity of the tax system and the level of unemployment benefits. We generate a severe recession using historical data and simulate the impact of our automatic fiscal policy. We assume that the Federal Reserve adheres to a counter–cyclical monetary policy governed by the interest rate (Taylor) rule estimated from historical data. We find that the interest rate rule alone mitigates the severe recession only modestly, whereas our automatic fiscal policy (together with the interest rate rule) substantially reduces the severity of the recession while generating only a relatively small rise in the government debt/GDP ratio.