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Alternative Public Spending Rules and Output Volatility

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  • Jean-Paul Lam
  • William Scarth

Abstract

One of the central lessons learned from the Great Depression was that adjusting government spending each year to balance the budget increases the volatility of output. We compare this policy with one that involves running temporary deficits and surpluses and an average budget balance of zero. Our analysis allows monetary policy to adjust to a change in fiscal regime, and the specifications for aggregate demand and supply are consistent with the "new neoclassical synthesis." Our results give only limited support to the conventional wisdom on fiscal rules and stability of output.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 02-37.

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Length: 24 pages Abstract: One of the central lessons learned from the Great Depression was that adjusting government spending each year to balance the budget increases the volatility of output. We compare this policy with one that involves running temporary deficits and surpluses and an average budget balance of zero. Our analysis allows monetary policy to adjust to a change in fiscal regime, and the specifications for aggregate demand and supply are consistent with the "new neoclassical synthesis." Our results give only limited support to the conventional wisdom on fiscal rules and stability of output.
Date of creation: 2002
Date of revision:
Handle: RePEc:bca:bocawp:02-37

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Keywords: Economic models; Fiscal policy; Transmission of monetary policy;

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References

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  1. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  2. McCallum, Bennett T, 1980. "Rational Expectations and Macroeconomic Stabilization Policy: An Overview," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(4), pages 716-46, November.
  3. Christiano, Lawrence J., 1984. "A reexamination of the theory of automatic stabilizers," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 20(1), pages 147-206, January.
  4. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
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  6. Helliwell, John & Gorbet, Fred, 1971. "Assessing the Dynamic Efficiency of Automatic Stabilizers," Journal of Political Economy, University of Chicago Press, vol. 79(4), pages 826-45, July-Aug..
  7. Svensson, Lars E. O., 1998. "Inflation targeting as a monetary policy rule," CFS Working Paper Series 1998/16, Center for Financial Studies (CFS).
  8. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  9. Darrel Cohen & Glenn Follette, 2000. "The automatic fiscal stabilizers: quietly doing their thing," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 35-67.
  10. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  11. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  12. Alan J. Auerbach & Daniel R. Feenberg, 2000. "The Significance of Federal Taxes as Automatic Stabilizers," Journal of Economic Perspectives, American Economic Association, vol. 14(3), pages 37-56, Summer.
  13. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  14. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  15. Smyth, David J, 1974. "Built-in Flexibility of Taxation and Stability in a Simple Dynamic IS-LM Model," Public Finance = Finances publiques, , vol. 29(1), pages 111-14.
  16. Alberto Alesina & Tamim Bayoumi, 1996. "The Costs and Benefits of Fiscal Rules: Evidence from U.S. States," NBER Working Papers 5614, National Bureau of Economic Research, Inc.
  17. Levinson, Arik, 1998. "Balanced Budgets and Business Cycles: Evidence from the States," National Tax Journal, National Tax Association, vol. 51(n. 4), pages 715-32, December.
  18. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  19. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  20. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  21. Jonathan Millar, 1997. "The Effects of Budget Rules on Fiscal Performance and Macroeconomic Stabilization," Working Papers 97-15, Bank of Canada.
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