The Rational Expectations Revolution made the entire profession think more about dynamics, particularly about the dynamics of neoclassical (micro-based) models. The foundation for considering models of economic change over time had, of course, been laid in previous decades by Domar, Harrod, Koopmans, Samuelson, Solow, Diamond, Phelps, Stiglitz, Cass, Shell, Sidrausky, Tobin, Uzawa and numerous other growth theorists. So most of the theoretical machinery was well in place by the time Diamond, Feldstein, Stiglitz, Sheshinski and other public finance economists started v l dressing the issue of the dynamic impacts of various fiscal policies.
Feldstein’s contribution here in stimulating research on fiscal policy and growth cannot be overstated. His 1974 debate with Robert Barro (1974) about the impact of government debt and unfunded social security fascinated a generation of graduate students who realized that fiscal policy could be a lot more interesting that simply shifting an IS curve. Feldstein (1974) not only rekindled a two century-long debate about the burden of the debt. He also showed that explicit government debt policies were not unique in their ability to generate large intergenerational transfers.
Finally, in stressing social security’s incentives for early retirement, Feldstein raised the more general question of how the entire panoply of effective marginal taxes and transfers could affect an economy’s long-run health. Another key contribution by Feldstein during this period was his 1977 paper (Feldstein 1977) on the burden of a land rent tax. This paper demonstrated that, by altering the market valuation of capital assets, fiscal policy can could effect intergenerational redistributions and alter the economy’s growth path and long-run rest point.
Feldstein’s theoretical work was couched in simple models. As such it provided a qualitative sense of how fiscal policies could influence economic. Although his empirical work provided some quantitative feel for the potential impacts of particular policies, Feldstein left five major issues unresolved. First, what were the long-run quantitative effects of fiscal reforms in more realistic multiperiod models? Second, how long did it take to get to the long-run? Third, were short run policy effects necessarily of the same sign as long run effects? Fourth, what was the structural relationship between alternative fiscal policies that effected quite similar intergenerational redistributions and why did they eventuate in such different measures of official government debt? Fifth, how much of the potential long-run improvement in an economy’s well being arising from fiscal reforms was the result of efficiency improvements as opposed to the sacrifice of those alive in the short and intermediate runs?