Dynamic Scoring: An Assessment of Fiscal Closing Assumptions

Abstract

Analysis of fiscal policy changes using general equilibrium models with forward-looking agents typically requires the modeler to assume a counterfactual adjustment to some fiscal instrument in order to achieve the debt sustainability implied by the government's intertemporal budget constraint. Since the fiscal instrument chosen to close the model can induce economic behavior unrelated to the policy change in models where Ricardian Equivalence does not hold, noise may be introduced into the analysis. In this paper we use such an overlapping generations framework to examine the impact of alternative fiscal closing assumptions on projected changes to economic aggregates over the ten-year 'budget window' following a change in tax policy, assessing the extent to which the noise associated with a particular fiscal instrument can be mitigated. We find that while quantitative differences in projected macroeconomic activity can be observed across alternative fiscal instruments, these differences tend to shrink as the date that fiscal instruments begin to adjust is delayed into the future. Since the particular fiscal instrument chosen to achieve debt sustainability can then become relatively unimportant, the reliability of policy analysis obtained using this class of models may be improved.