THE ANALYSIS OF INTERREGIONAL FISCAL POLICY: A SIMULATION APPROACH

Conventional wisdom is that fiscal policy at the regional level is ineffective. Recent concern about stability of bond-financed fiscal policy imposes an additional constraint on the effectiveness of interregional fiscal policy. In the conventional macroeconomic model, regional public sectors are ignored, or are at most a subset of the national model. Fiscal and financial interrelationships among different levels of government have not been investigated thoroughly in the literature.;We examine a once-and-for-all fiscal policy change in the interregional model with and without the federal sector. The simulated results based on an acceptable range of parameter values show that the system cannot generate a stable long-run equilibrium. At best, a quasi-equilibrium is attainable in that only the overall government budget constraint is satisfied.;A once-and-for-all policy change is not only irrelevant in reality since public sectors react to actual economic situations, but also becomes a source of instability in an interregional model.;The final version of the interregional model incorporates an endogenous fiscal policy. Government expenditure becomes an endogenous variable and fiscal policies are target-oriented. The income level and balanced-budget are the main targets. A system of government expenditure reaction functions is built into the model with each government adopting an active fiscal policy in order to achieve income and balanced-budget targets. The public sector adjusts its fiscal policy according to the last period's economic situation. The extent of these government expenditure changes is governed by the target-adjustment parameters. Each government has its own priority or objective in determining the target-adjustment parameter values.;The purpose of this dissertation is to provide a theoretical framework for the analysis of interregional fiscal policy. We argue that all government budget constraints must be explicitly included in the model, and regions become the major building blocks of the system. Stability of the system then depends on the fiscal and financial interrelationships among different levels of government.;The simulated results show that the interregional model can generate a stable long-run equilibrium, regardless of the mode of federal financing policy. The effectiveness of an active fiscal policy and the critical limits of these target-adjustment parameters are investigated. Of prime importance is the finding that an independent regional fiscal policy cannot generate a stable long-run equilibrium. Only when all governments cooperate actively in fiscal management can the system achieve the targets. Thus, the final version of the interregional model not only rejects independent regional fiscal policies, but requires coordination and cooperation among all governments in devising a viable fiscal policy. Our simulation findings therefore strengthen the case for fiscal federalism.