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Deficit Limits, Budget Rules and Fiscal Policy

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  • Paolo Manasse

Abstract

The paper presents a simple model for discussing the effects of deficit limits and budget rules on fiscal policy. I find that limits on deficit-output ratios provide incentives to implement procyclical policies when the economy is in intermediate states, and countercyclical policies only in very "good" and very "bad" economic times. As a result, fiscal "reaction functions" are not monotonically related to the state of the economy. Deficit limits are found to exert discipline only provided the limit is tight and the expected sanction large, albeit at a relatively large welfare cost. Moreover, when fiscal choices are made under a veil of ignorance about the output gap, an increase in volatility is likely to raise the level of the budget deficit. Finally, concerning the design of fiscal frameworks, when excessive deficits arise from a political bias, deficit limits should be symmetric and not state-contingent.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/120.

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Length: 19
Date of creation: 01 Jun 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/120

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Keywords: Fiscal management; Budget deficits; Economic growth; Economic models; fiscal policy; probability; equation; excessive deficits; fiscal frameworks; fiscal reaction; budget deficit; fiscal reaction function; fiscal rules; functional form; fiscal discipline; logarithm; fiscal rule; fiscal constraint; fiscal ? reaction; fiscal ? reaction functions; fiscal decisions; algebra; excessive deficit procedure; probability density function; tax rates; taxation; fiscal policy rules; tax base; empirical implication; public debt; public finance; tax revenues; probability density; fiscal affairs; fiscal authorities; fiscal stabilization; fiscal deficit; stochastic model; fiscal reaction functions; tax breaks;

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References

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  1. Grossman, Gene & Helpman, Elhanan, 1993. "Protection for Sale," CEPR Discussion Papers 827, C.E.P.R. Discussion Papers.
  2. Bottazzi, Laura & Manasse, Paolo, 2002. "Asymmetric Information and Monetary Policy in Common Currency Areas," CEPR Discussion Papers 3484, C.E.P.R. Discussion Papers.
  3. Bordignon, Massimo & Manasse, Paolo & Tabellini, Guido, 1996. "Optimal Regional Redistribution Under Asymmetric Information," CEPR Discussion Papers 1437, C.E.P.R. Discussion Papers.
  4. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
  5. Torsten Persson & Gerard Roland & Guido Tabellini, 2003. "How Do Electoral Rules Shape Party Structures, Government Coalitions and Economic Policies?," Working Papers 251, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  6. Feldstein, Martin, 2005. "The euro and the stability pact," Journal of Policy Modeling, Elsevier, vol. 27(4), pages 421-426, June.
  7. Manasse, Paolo, 1996. "Are taxes too low?," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1263-1288.
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Cited by:
  1. Håvard Halland & Michael Bleaney, . "Explaining The Procyclicality of Fiscal Policy in Developing Countries," Discussion Papers 11/09, University of Nottingham, CREDIT.
  2. Jacopo Cimadomo, 2007. "Fiscal Policy in Real Time," Working Papers 2007-10, CEPII research center.
  3. Xavier Debrun & Manmohan S. Kumar, 2007. "The Discipline-Enhancing Role of Fiscal Institutions," IMF Working Papers 07/171, International Monetary Fund.
  4. Paolo Manasse & Ugo Panizza & Laura Dos Reis, 2007. "Targeting the Structural Balance ," IDB Publications 6722, Inter-American Development Bank.
  5. Paolo Manasse, 2006. "Procyclical Fiscal Policy," IMF Working Papers 06/27, International Monetary Fund.

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