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A better budget rule

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Author Info

  • Michael Dothan

    (Guy F. Atkinson Professor of Economics and Finance, Atkinson Graduate School of Management, Willamette University, and author of Prices in Financial Markets)

  • Fred Thompson

    (Director of Willamette University's Center for Governance and Public Policy Research. He is a recipient of the Association for Budgeting and Financial Management's Aaron B. Wildavsky award for scholarly achievement)

Abstract

Debt limits, interest coverage ratios, one-off balanced budget requirements, pay-as-you-go rules, and tax and expenditure limits are among the most important fiscal rules for constraining intertemporal transfers. There is considerable evidence that the least costly and most effective of such rules are those that focus directly on the rate of spending growth, even with their seemingly ad hoc nature and possibilities for circumvention. In this paper, we use optimal control theory and martingale methods to justify a transparent, nonarbitrary rule governing maximum sustainable rate of spending growth, treating the revenue structure of a jurisdiction as a given continuous-time stochastic process. Our results can be used to determine whether a proposed rate of spending growth is sustainable or not. © 2009 by the Association for Public Policy Analysis and Management

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File URL: http://hdl.handle.net/10.1002/pam.20441
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Policy Analysis and Management.

Volume (Year): 28 (2009)
Issue (Month): 3 ()
Pages: 463-478

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Handle: RePEc:wly:jpamgt:v:28:y:2009:i:3:p:463-478

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Web page: http://www3.interscience.wiley.com/journal/34787/home

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References

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  1. Jonathan A. Rodden & Gunnar S. Eskeland (ed.), 2003. "Fiscal Decentralization and the Challenge of Hard Budget Constraints," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262182297, December.
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "The Forgotten History of Domestic Debt," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 121(552), pages 319-350, 05.
  3. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Alberto Alesina & Roberto Perotti, 1996. "Budget Deficits and Budget Institutions," IMF Working Papers 96/52, International Monetary Fund.
  5. Robert Berne & Leanna Stiefel, 1993. "Cutback budgeting: The long-term consequences," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 12(4), pages 664-684.
  6. Bayoumi, Tamim & Goldstein, Morris & Woglom, Geoffrey, 1995. "Do Credit Markets Discipline Sovereign Borrowers? Evidence from the U.S. States," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(4), pages 1046-59, November.
  7. Willem H. Buiter, 1990. "Principles of Budgetary and Financial Policy," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262524139, December.
  8. Laibson, David, 1998. "Life-cycle consumption and hyperbolic discount functions," European Economic Review, Elsevier, Elsevier, vol. 42(3-5), pages 861-871, May.
  9. David M. Primo, 2006. "Stop Us Before We Spend Again: Institutional Constraints On Government Spending," Economics and Politics, Wiley Blackwell, Wiley Blackwell, vol. 18(3), pages 269-312, November.
  10. Bharat Trehan & Carl E. Walsh, 1988. "Testing intertemporal budget constraints: theory and applications to U. S. federal budget and current account deficits," Working Papers in Applied Economic Theory, Federal Reserve Bank of San Francisco 88-03, Federal Reserve Bank of San Francisco.
  11. Marco Battaglini & Stephen Coate, 2008. "Fiscal Policy over the Real Business Cycle: A Positive Theory," NBER Working Papers 14047, National Bureau of Economic Research, Inc.
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Cited by:
  1. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  2. Popescu, Razvan-Florin & Prodan, Sergiu, 2010. "The analysis of budget rules and macroeconomic implications in several developed economies," MPRA Paper 25897, University Library of Munich, Germany, revised 2010.

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