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Deficit Limits and Fiscal Rules for Dummies

  • Paolo Manasse

The paper shows that common fiscal rules, such as a limit to the deficit-output ratio, induce an “escape clause”–type fiscal policy, similar to that studied for monetary policy by Flood and Isard (1988 and 1989) and Lohmann (1992): The government resorts to an active stabilization (for example, countercyclical) policy only during “exceptional times” by running deficits in recession phases and surpluses during economic booms. In contrast, it optimally chooses a procyclical policy in intermediate states of the economy, for example, by raising the budget deficit when output improves. Because the optimal fiscal reaction function in the presence of fiscal rules is not monotonous in output, the standard estimates that assume linearity are prone to a serious bias, and the conclusions on the pro- or countercyclical properties of fiscal policy found in the literature are likely to be unreliable. IMF Staff Papers (2007) 54, 455–473. doi:10.1057/palgrave.imfsp.9450015

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Article provided by Palgrave Macmillan in its journal IMF Staff Papers.

Volume (Year): 54 (2007)
Issue (Month): 3 (July)
Pages: 455-473

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Handle: RePEc:pal:imfstp:v:54:y:2007:i:3:p:455-473
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  1. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
  2. Grossman, Gene M & Helpman, Elhanan, 1994. "Protection for Sale," American Economic Review, American Economic Association, vol. 84(4), pages 833-50, September.
  3. Massimo Bordignon & Paolo Manasse & Guido Tabellini, . "Optimal Regional Redistribution Under Asymmetric Information," Working Papers 93, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  4. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  5. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
  6. Laura Bottazzi & Paolo Manasse, . "Asymmetric Information and Monetary Policy in Common Currency Areas," Working Papers 217, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  7. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  8. Robert Flood & Peter Isard, 1989. "Simple Rules, Discretion and Monetary Policy," NBER Working Papers 2934, National Bureau of Economic Research, Inc.
  9. Fabrizio Balassone & Maura Francese, 2004. "Cyclical asymmetry in fiscal policy, debt accumulation and the Treaty of Maastricht," Temi di discussione (Economic working papers) 531, Bank of Italy, Economic Research and International Relations Area.
  10. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  11. Bouthevillain, Carine & Cour-Thimann, Philippine & van de Dool, Gerrit & Hernández de Cos, Pablo & Langenus, Geert & Mohr, Matthias & Momigliano, Sandro & Tujula, Mika, 2001. "Cyclically adjusted budget balances: an alternative approach," Working Paper Series 0077, European Central Bank.
  12. Manasse, Paolo, 1996. "Are taxes too low?," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1263-1288.
  13. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  14. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
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