The tale of the donkey and the elephant: an estimated optimal fiscal policy rule for the US

ABSTRACT

We derive an optimal fiscal policy rule that reflects the US government’s desire to reduce fluctuations in the output gap and the primary deficit in the post-World War II period. The results from Bayesian estimations show a lower weight on output gap stabilization under predominant democratic presidencies relative to republican ones. The opposite holds with respect to maintaining a zero primary deficit. Our time-consistent fiscal rule indicates a countercyclical government response to GDP fluctuations at all times.

KEYWORDS:

• Fiscal policy
• optimal simple rule
• time-consistency
• New-Keynesian model
• Bayesian estimation

JEL CLASSIFICATION:

• C11
• C61
• E12
• E61
• E62.

Supplementary material

Supplemental data for this article can be accessed here.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Note that it can be shown that the condition for saddle point stability is given by the inequality $\zeta +(\beta -1){\sigma }^{-1}{\varphi }_g>0$ where the expression $\zeta =(1-\beta ){\varphi }_y+({\varphi }_{\pi }-1)\kappa$ is known from Bullard and Mitra (2002). It follows that the Taylor principle, i.e., ${\varphi }_{\pi }>1$, is not strictly required to hold for given values of ${\varphi }_g$ in this version of the purely forward-looking New-Keynesian model.

² All corresponding files used for data alignment and estimations via Dynare together with a technical appendix are downloadable via the journal’s web page.