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"The Sensitivity of Fiscal-Policy Effects to Assumptions About
the Behavior of the Federal Reserve," Econometrica,
September 1978, 1165-1179.
pdf file (914KB).
The purpose of this paper is to examine within the context of a particular
U.S. econometric model the sensitivity of fiscal policy effects to
alternative assumptions about the behavior of the Federal Reserve. Five
cases are considered, four in which Fed behavior is exogenous and one in
which Fed behavior is endogenous. In each of the four exogenous cases the
Fed is assumed to control a particular variables, which is then taken to be
exogenous for purposes of the fiscal-policy experiments. For the
endogenous case an estimated equation explaining Fed behavior is added to the
model, and the expanded model is used to perform the experiments. The
results of some optimal control experiments are also reported in this paper.
These latter experiments are designed to examine the sensitivity of
optimal fiscal policies to alternative assumptions about Fed behavior.
The main conclusion of this paper is that fiscal policy effects and optimal
fiscal policies are quite sensitive to assumptions about the behavior
of the Fed.
This paper resulted in an important addition to the US model as specified in
1976#1, namely an estimated interest rate
reaction function of the Federal Reserve. This function is equation
30 in the current version of the model. The reaction function in this
paper was one of the first monetary policy rules to be specified with
the interest rate as the target variable. This paper shows that
fiscal policy effects in the US model are sensitive to what is assumed
about Fed behavior. Similarly, optimal control results are sensitive to
Fed behavioral assumptions.