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Rules Versus Discretion In Fiscal Policy

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  • CARLUCCIO BIANCHI
  • MARIO MENEGATTI

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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Suggested Citation

  • Carluccio Bianchi & Mario Menegatti, 2012. "Rules Versus Discretion In Fiscal Policy," Manchester School, University of Manchester, vol. 80(5), pages 603-629, September.
  • Handle: RePEc:bla:manchs:v:80:y:2012:i:5:p:603-629
    DOI: j.1467-9957.2011.02240.x
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    File URL: http://hdl.handle.net/10.1111/j.1467-9957.2011.02240.x
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    References listed on IDEAS

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    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
    2. 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, vol. 91(4), pages 589-610, August.
    3. Favero, Carlo A. & Giavazzi, Francesco, 2007. "Debt and the Effects of Fiscal Policy," CEPR Discussion Papers 6092, C.E.P.R. Discussion Papers.
    4. Steven J. Davis & Magnus Henrekson, 2004. "Tax Effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich-Country Comparisons," NBER Working Papers 10509, National Bureau of Economic Research, Inc.
    5. George Kopits & Steven A. Symansky, 1998. "Fiscal Policy Rules," IMF Occasional Papers 162, International Monetary Fund.
    6. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
    7. Roberto Perotti, 2005. "Estimating the effects of fiscal policy in OECD countries," Proceedings, Federal Reserve Bank of San Francisco.
    8. Alberto Alesina & Guido Tabellini, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 403-414.
    9. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1329-1368.
    10. Fabrizio Balassone & Daniele Franco, 2000. "Public investment, the Stability Pact and the ‘golden rule’," Fiscal Studies, Institute for Fiscal Studies, vol. 21(2), pages 207-229, June.
    11. Kneller, Richard & Bleaney, Michael F. & Gemmell, Norman, 1999. "Fiscal policy and growth: evidence from OECD countries," Journal of Public Economics, Elsevier, vol. 74(2), pages 171-190, November.
    12. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
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    Cited by:

    1. DUMITRESCU, Bogdan Andrei, 2015. "The Fiscal Framework In Romania – The Efficiency Of Fiscal Rules," Studii Financiare (Financial Studies), Centre of Financial and Monetary Research "Victor Slavescu", vol. 19(3), pages 91-106.

    More about this item

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • H68 - Public Economics - - National Budget, Deficit, and Debt - - - Forecasts of Budgets, Deficits, and Debt

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