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Rules versus discretion in fiscal policy

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  • C. Bianchi
  • M. Menegatti

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Abstract

This paper purports to apply the Kydland-Prescott framework of dynamic inconsistency to the case of fiscal policy, by considering the trade-off between output and debt stabilization. The Government budget constraint provides the link between debt dynamics and the level of activity, influenced by fiscal policy. Contrary to what happens in the monetary policy framework, however, a commitment is not always superior to discretion, even in the absence of uncertainty, but only when the public debt-GDP ratio is sufficiently large. The introduction of uncertainty, as usual, implies a reduction in the net benefit generated by the adoption of a fixed rule.

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File URL: http://swrwebeco.econ.unipr.it/RePEc/pdf/I_2007-05.pdf
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Bibliographic Info

Paper provided by Department of Economics, Parma University (Italy) in its series Economics Department Working Papers with number 2007-EP05.

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Length: 27
Date of creation: 2007
Date of revision:
Handle: RePEc:par:dipeco:2007-ep05

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Keywords: rules; discretion; time inconsistency; fiscal policy;

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  1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 589-610, August.
  2. Alesina, Alberto & Tabellini, Guido, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(3), pages 403-14, July.
  3. Kneller, Richard & Bleaney, Michael F. & Gemmell, Norman, 1999. "Fiscal policy and growth: evidence from OECD countries," Journal of Public Economics, Elsevier, Elsevier, vol. 74(2), pages 171-190, November.
  4. Roberto Perotti, 2004. "Estimating the effects of fiscal policy in OECD countries," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 276, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
  6. Davis, Steven J. & Henrekson, Magnus, 2004. "Tax Effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich-Country Comparisons," Working Paper Series in Economics and Finance, Stockholm School of Economics 560, Stockholm School of Economics.
  7. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  8. Fabrizio Balassone & Daniele Franco, 2000. "Public investment, the Stability Pact and the ‘golden rule’," Fiscal Studies, Institute for Fiscal Studies, Institute for Fiscal Studies, vol. 21(2), pages 207-229, June.
  9. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall.
  10. Carlo Favero & Francesco Giavazzi, 2007. "Debt and the Effects of Fiscal Policy," NBER Working Papers 12822, National Bureau of Economic Research, Inc.
  11. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  12. George Kopits & Steven A. Symansky, 1998. "Fiscal Policy Rules," IMF Occasional Papers, International Monetary Fund 162, International Monetary Fund.
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