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Consistent flexibility: Enforcement of deficit rules through political incentives

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  • Dotti, Valerio
  • Janeba, Eckhard

Abstract

We study the optimal design of a deficit rule in a model in which the government is present-biased, shocks to tax revenues make rule compliance stochastic, and a rule violation reduces the payoff from holding office. We show that: (i) the benchmark policy of the social planner can be always implemented via an optimal nonlinear deficit rule and under certain conditions even under a linear rule; (ii) the optimal rule prescribes a zero structural deficit but only partially accounts for shocks; and (iii) a government with a stronger ex-ante deficit bias should be granted a higher degree of flexibility.

Suggested Citation

  • Dotti, Valerio & Janeba, Eckhard, 2023. "Consistent flexibility: Enforcement of deficit rules through political incentives," European Journal of Political Economy, Elsevier, vol. 79(C).
    • Handle: RePEc:eee:poleco:v:79:y:2023:i:c:s0176268023000939
    DOI: 10.1016/j.ejpoleco.2023.102449
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    More about this item

    Keywords

    Fiscal rules; Flexibility; Policy design; Deficit bias;
    All these keywords.

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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