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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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Related research

Keywords: Fiscal management; Budget deficits; Economic growth; Economic models;

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References

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  1. Torsten Persson & Gerard Roland & Guido Tabellini, 2004. "How Do Electoral Rules Shape Party Structures, Government Coalitions, and Economic Policies?," CESifo Working Paper Series 1115, CESifo Group Munich.
  2. Grossman, Gene M & Helpman, Elhanan, 1994. "Protection for Sale," American Economic Review, American Economic Association, vol. 84(4), pages 833-50, September.
  3. Reinhart, Carmen & Kaminsky, Graciela & Vegh, Carlos, 2004. "When it rains, it pours: Procyclical capital flows and macroeconomic policies," MPRA Paper 13883, University Library of Munich, Germany.
  4. Bordignon, Massimo & Manasse, Paolo & Tabellini, Guido, 1996. "Optimal Regional Redistribution Under Asymmetric Information," CEPR Discussion Papers 1437, C.E.P.R. Discussion Papers.
  5. Bottazzi, Laura & Manasse, Paolo, 2005. "Asymmetric Information and Monetary Policy in Common Currency Areas," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(4), pages 603-21, August.
  6. Manasse, Paolo, 1996. "Are taxes too low?," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1263-1288.
  7. Feldstein, Martin, 2005. "The euro and the stability pact," Journal of Policy Modeling, Elsevier, vol. 27(4), pages 421-426, June.
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Cited by:
  1. Candelon, Bertrand & Muysken, Joan & Vermeulen, Robert, 2007. "Fiscal Policy and Monetary Integration in Europe: An Update," Research Memorandum 050, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  2. Jacopo Cimadomo, 2007. "Fiscal Policy in Real Time," Working Papers 2007-10, CEPII research center.
  3. Paolo Manasse, 2006. "Procyclical Fiscal Policy: Shocks, Rules, and Institutions - A View From MARS," IMF Working Papers 06/27, International Monetary Fund.
  4. Xavier Debrun & Manmohan S. Kumar, 2007. "The Discipline-Enhancing Role of Fiscal Institutions: Theory and Empirical Evidence," IMF Working Papers 07/171, International Monetary Fund.
  5. Håvard Halland & Michael Bleaney, . "Explaining The Procyclicality of Fiscal Policy in Developing Countries," Discussion Papers 11/09, University of Nottingham, CREDIT.
  6. Laura dos Reis & Paolo Manasse & Ugo Panizza, 2007. "Targeting the Structural Balance," Research Department Publications 4507, Inter-American Development Bank, Research Department.
  7. Candelon, Bertrand & Muysken, Joan & Vermeulen, Robert, 2008. "Fiscal Policy and Monetary Integration in Europe: An Update," Research Memorandum 038, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).

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