Book Chapter

Tax-rate rules for reducing government debt: An application of computational methods for macroeconomic stabilization

GC Lim, PD Mcnelis

The Oxford Handbook of Computational Economics and Finance | Published : 2018

Abstract

This chapter uses an example to demonstrate the steps of specifying, calibrating, solving, and simulating a macroeconomic model in order to evaluate alternative policies for reducing domestic public debt. It extends the simple closed-economy New Keynesian model by incorporating the zero lower bound and asymmetric wage adjustment (in which wages are much more rigid in the downward direction). We examine the dynamics of adjustment, given a sharp increase in government debt due to a once-only big increase in spending. We find that selective tax-rate rules, incorporating a degree of tax relief in a period of fiscal consolidation, are effective instruments for rapidly reducing the overhang of a l..

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