Econometrica: Sep, 1978, Volume 46, Issue 5

The Sensitivity of Fiscal Policy Effects to Assumptions about the Behavior of the Federal Reserve

https://doi.org/0012-9682(197809)46:5<1165:TSOFPE>2.0.CO;2-P
p. 1165-1179

Ray C. Fair

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 variable, 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.