The limits to discretionary fiscal stabilization policy

The use of discretionary fiscal policy as a counter-cyclical tool has declined in popularity over the last 30 years. This paper examines the extent to which this decline is justified in terms of developments in macroeconomic theory over this period. Both a small calibrated model and a larger econometric model suggest that the intertemporal consumer will smooth away most of the impact of temporary tax changes, even when additional discounting and credit constraints are allowed for. However, this analysis suggests a more powerful role for other forms of fiscal policy, such as government objections to the use of discretionary fiscal stabilization policy, and makes a tentative suggestion as to how these might be overcome.