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Deficit Limits and Fiscal Rules for Dummies

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  • Paolo Manasse

Abstract

The paper shows that common fiscal rules, such as a limit to the deficit-output ratio, induce an “escape clause”–type fiscal policy, similar to that studied for monetary policy by Flood and Isard (1988 and 1989) and Lohmann (1992): The government resorts to an active stabilization (for example, countercyclical) policy only during “exceptional times” by running deficits in recession phases and surpluses during economic booms. In contrast, it optimally chooses a procyclical policy in intermediate states of the economy, for example, by raising the budget deficit when output improves. Because the optimal fiscal reaction function in the presence of fiscal rules is not monotonous in output, the standard estimates that assume linearity are prone to a serious bias, and the conclusions on the pro- or countercyclical properties of fiscal policy found in the literature are likely to be unreliable. IMF Staff Papers (2007) 54, 455–473. doi:10.1057/palgrave.imfsp.9450015

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal IMF Staff Papers.

Volume (Year): 54 (2007)
Issue (Month): 3 (July)
Pages: 455-473

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Handle: RePEc:pal:imfstp:v:54:y:2007:i:3:p:455-473

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References

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  1. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, American Economic Association, vol. 82(1), pages 273-86, March.
  2. Gene M. Grossman & Elhanan Helpman, 1992. "Protection For Sale," NBER Working Papers 4149, National Bureau of Economic Research, Inc.
  3. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 101-121.
  4. Bouthevillain, C. & Van Den Dool, G. & Langenus, G. & Mohr, M. & Momigliano, S. & Tujula, M. & De Cos, P.H. & Cour-Thimann, Philippine, 2001. "Cyclically Adjusted Budget Balances: an Alternative Approach," Papers 77, Quebec a Montreal - Recherche en gestion.
  5. L. Bottazzi & P. Manasse, 2002. "Asymmetric Information and Monetary Policy in Common Currency Areas," Working Papers 444, Dipartimento Scienze Economiche, Universita' di Bologna.
  6. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
  7. Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," NBER Working Papers 10253, National Bureau of Economic Research, Inc.
  8. Fabrizio Balassone & Maura Francese, 2004. "Cyclical asymmetry in fiscal policy, debt accumulation and the Treaty of Maastricht," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 531, Bank of Italy, Economic Research and International Relations Area.
  9. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(5), pages 940-71, October.
  10. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, American Economic Association, vol. 85(1), pages 150-67, March.
  11. Bordignon, Massimo & Manasse, Paolo & Tabellini, Guido, 1996. "Optimal Regional Redistribution Under Asymmetric Information," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1437, C.E.P.R. Discussion Papers.
  12. Robert Flood & Peter Isard, 1989. "Simple Rules, Discretion and Monetary Policy," NBER Working Papers 2934, National Bureau of Economic Research, Inc.
  13. Manasse, Paolo, 1996. "Are taxes too low?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 20(6-7), pages 1263-1288.
  14. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
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Cited by:
  1. W. D. Gregori, 2014. "Fiscal Rules and Public Spending: Evidence from Italian Municipalities," Working Papers wp923, Dipartimento Scienze Economiche, Universita' di Bologna.
  2. Sacchi, Agnese & Salotti, Simone, 2014. "The impact of national fiscal rules on the stabilisation function of fiscal policy," MPRA Paper 56982, University Library of Munich, Germany.
  3. Fabrizio Carmignani, . "Cyclical fiscal policy in developing countries: the case of Africa," MRG Discussion Paper Series, School of Economics, University of Queensland, Australia 2408, School of Economics, University of Queensland, Australia.
  4. Carmignani, Fabrizio, 2010. "Cyclical fiscal policy in Africa," Journal of Policy Modeling, Elsevier, Elsevier, vol. 32(2), pages 254-267, March.

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