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Debt stabilizing fiscal rules

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  • Michel, Philippe
  • von Thadden, Leopold
  • Vidal, Jean-Pierre

Abstract

Unstable government debt dynamics can typically be corrected by various fiscal instruments, like appropriate adjustments in government spending, public transfers, or taxes. This paper investigates properties of state-contingent debt targeting rules which link stabilizing budgetary adjustments around a target level of long-run debt to the state of the economy. The paper establishes that the size of steady-state debt is a key determinant of whether it is possible to find a rule of this type which can be implemented under all available fiscal instruments. Specifically, considering linear feedback rules, the paper demonstrates that there may well exist a critical level of debt beyond which this is no longer possible. From an applied perspective, this finding is of particular relevance in the context of a monetary union with decentralized fiscal policies. Depending on the level of long-run debt, there might be a conflict between a common fiscal framework which tracks deficit developments as a function of the state of the economy and the unrestricted choice of fiscal policy instruments at the national level. JEL Classification: E63, H62

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Paper provided by European Central Bank in its series Working Paper Series with number 0576.

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Date of creation: Jan 2006
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Handle: RePEc:ecb:ecbwps:20060576

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Keywords: fiscal regimes; overlapping generations;

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Cited by:
  1. Campbell Leith & Leopold von Thadden, 2006. "Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers," Working Papers 2006_6, Business School - Economics, University of Glasgow.
  2. Mongelli, Francesco Paolo & Vega, Juan Luis, 2006. "What effects is EMU having on the euro area and its member countries? An overview," Working Paper Series 0599, European Central Bank.

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