Use of Fiscal Policy Reaction Functions in Analyzing the Macroeconomic Effects of Tax Policy

Abstract

We model an empirically estimated fi scal policy reaction function (FPRF) in a macroeconomic growth model. In general, an FPRF uses information about the path of past and expected future macroeconomic events and fi scal policy to forecast future fi scal policy reactions. We show that an empirically estimated FPRF, consistent with past legislative activity, can return unsustainable fi scal forecasts to sustainability. However, we also demonstrate that modeling other variants of an FPRF, equally consistent with the literature, do not return fi scal forecasts to sustainability. We conclude that additional empirical work is necessary before implementation of an FPRF in macroeconomic models could decisively improve modeling results or their presentation.