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A better budget rule

  • Michael Dothan

    (Guy F. Atkinson Professor of Economics and Finance, Atkinson Graduate School of Management, Willamette University, and author of Prices in Financial Markets)

  • Fred Thompson

    (Director of Willamette University's Center for Governance and Public Policy Research. He is a recipient of the Association for Budgeting and Financial Management's Aaron B. Wildavsky award for scholarly achievement)

Debt limits, interest coverage ratios, one-off balanced budget requirements, pay-as-you-go rules, and tax and expenditure limits are among the most important fiscal rules for constraining intertemporal transfers. There is considerable evidence that the least costly and most effective of such rules are those that focus directly on the rate of spending growth, even with their seemingly ad hoc nature and possibilities for circumvention. In this paper, we use optimal control theory and martingale methods to justify a transparent, nonarbitrary rule governing maximum sustainable rate of spending growth, treating the revenue structure of a jurisdiction as a given continuous-time stochastic process. Our results can be used to determine whether a proposed rate of spending growth is sustainable or not. © 2009 by the Association for Public Policy Analysis and Management

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Policy Analysis and Management.

Volume (Year): 28 (2009)
Issue (Month): 3 ()
Pages: 463-478

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Handle: RePEc:wly:jpamgt:v:28:y:2009:i:3:p:463-478
Contact details of provider: Web page: http://www3.interscience.wiley.com/journal/34787/home

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