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date: 30 November 2020

Abstract and Keywords

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 large stock of public debt.

Keywords: tax rate rules, fiscal consolidation, zero lower bound, asymmetric wage rigidity, computational macroeconomics, perturbation method, projection method, logistic neural networks, Judd-Gaspar statistics, closed-economy model

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