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Fiscal Rules and Discretion under Self-Enforcement

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  • Pierre Yared

    (Columbia University)

Abstract

We study a fiscal policy model in which the government is present-biased towards public spending. Society chooses a fiscal rule to trade off the benefit of committing the government to not overspend against the benefit of granting it flexibility to react to privately observed shocks to the value of spending. Unlike prior work, we characterize rules that are self-enforcing: the government must prefer to comply with the rule rather than face the punishment that follows a breach, where any such punishment must also be self-enforcing. We show that the optimal rule is a maximally enforced deficit limit, which, if violated, leads to the worst punishment for the government. We provide a necessary and sufficient condition for the government to violate the deficit limit following sufficiently high shocks. Punishment takes the form of temporary overspending, after which the optimal rule is restored.

Suggested Citation

  • Pierre Yared, 2018. "Fiscal Rules and Discretion under Self-Enforcement," 2018 Meeting Papers 62, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:62
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    References listed on IDEAS

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    Cited by:

    1. Jean Barthélemy & Eric Mengus, 2017. "Credibility and Monetary Policy," Working Papers hal-03457527, HAL.
    2. Javier Bianchi & Pablo Ottonello & Ignacio Presno, 2023. "Fiscal Stimulus under Sovereign Risk," Journal of Political Economy, University of Chicago Press, vol. 131(9), pages 2328-2369.
    3. Valerio Dotti & Eckhard Janeba, 2020. "Consistent Flexibility: Enforcement of Fiscal Rules through Political Incentives," CESifo Working Paper Series 8440, CESifo.
    4. Jean Barthélemy & Eric Mengus & Guillaume Plantin, 2021. "The Central Bank, the Treasury, or the Market: Which One Determines the Price Level?," Working papers 855, Banque de France.
    5. repec:hal:spmain:info:hdl:2441/1lu2rbsv0n8pkqid81q0tfof3f is not listed on IDEAS
    6. Coate, Stephen & Milton, Ross T., 2019. "Optimal fiscal limits with overrides," Journal of Public Economics, Elsevier, vol. 174(C), pages 76-92.

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    More about this item

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H1 - Public Economics - - Structure and Scope of Government
    • P16 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Capitalist Institutions; Welfare State

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