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Rules Versus Discretion In Fiscal Policy

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  • CARLUCCIO BIANCHI
  • MARIO MENEGATTI

Abstract

This paper purports to apply the Kydland-Prescott framework of dynamic inconsistency to the case of fiscal policy, by considering the trade-off between output and debt stabilization. The Government budget constraint provides the link between debt dynamics and the level of activity, influenced by fiscal policy. Contrary to what happens in the monetary policy framework, however, a commitment is not always superior to discretion, even in the absence of uncertainty, but only when the public debt-GDP ratio is sufficiently large. The introduction of uncertainty, as usual, implies a reduction in the net benefit generated by the adoption of a fixed rule.

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Bibliographic Info

Article provided by University of Manchester in its journal The Manchester School.

Volume (Year): 80 (2012)
Issue (Month): 5 (09)
Pages: 603-629

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Handle: RePEc:bla:manchs:v:80:y:2012:i:5:p:603-629

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  1. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco.
  2. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1329-1368, November.
  3. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  4. Davis, Steven J. & Henrekson, Magnus, 2004. "Tax Effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich-Country Comparisons," Ratio Working Papers 57, The Ratio Institute.
  5. Carlo Favero & Francesco Giavazzi, 2007. "Debt and the effects of fiscal policy," Working Papers 07-4, Federal Reserve Bank of Boston.
  6. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  7. Alesina, Alberto & Tabellini, Guido, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 403-14, July.
  8. George Kopits & Steven A. Symansky, 1998. "Fiscal Policy Rules," IMF Occasional Papers 162, International Monetary Fund.
  9. Fabrizio Balassone & Daniele Franco, 2000. "Public investment, the Stability Pact and the ‘golden rule’," Fiscal Studies, Institute for Fiscal Studies, vol. 21(2), pages 207-229, June.
  10. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  11. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  12. Kneller, Richard & Bleaney, Michael F. & Gemmell, Norman, 1999. "Fiscal policy and growth: evidence from OECD countries," Journal of Public Economics, Elsevier, vol. 74(2), pages 171-190, November.
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