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Issues In The Design of Fiscal Policy Rules

Author

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  • Jonathan Portes

    (National Institute of Economic and Social Research (NIESR)
    Centre for Macroeconomics (CFM))

  • Simon Wren-Lewis

    (Merton College, Oxford)

Abstract

Theory suggests that government should as far as possible smooth taxes and its recurrent consumption spending, which means that government debt should act as a shock absorber, and any planned adjustments in debt should be gradual. This suggests that operational targets for governments (e.g. for 5 years ahead) should involve deficits rather than debt, because such rules will be more robust to shocks. Beyond that, fiscal rules need to reflect the constraints on monetary policy, and the extent to which governments are subject to deficit bias. Fiscal rules for countries in a monetary union or fixed exchange rate regime need to include a strong countercyclical element. Fiscal rules should also contain a ‘knock out’ if interest rates hit the zero lower bound: in that case the fiscal and monetary authorities should cooperate to formulate a fiscal expansion package that allows interest rates to rise above this bound. In more normal times, the design of fiscal policy rules is likely to depend on the extent to which governments are subject to deficit bias, and the effectiveness of any national fiscal council. For example, governments that had not shown a history of deficit bias could aim to target deficits five years ahead (rolling targets), and these would not require cyclical adjustment. In contrast, governments that were more prone to bias could target a cyclically adjusted deficit at the end of their expected period of office. In both cases fiscal councils would have an important role to play, in ensuring plans were implemented in the first case and allowing for departures from target when external shocks occurred in the second.

Suggested Citation

  • Jonathan Portes & Simon Wren-Lewis, 2014. "Issues In The Design of Fiscal Policy Rules," Discussion Papers 1412, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1412
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    References listed on IDEAS

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    1. Obstacles to full employment
      by chris in Stumbling and Mumbling on 2019-02-05 15:54:14

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    3. J.W. Mason & Arjun Jayadev, 2015. "Lost in Fiscal Space: Some Simple Analytics of Macroeconomic Policy in the Spirit of Tinbergen, Wicksell and Lerner," Working Papers 2015_05, University of Massachusetts Boston, Economics Department.
    4. Hilde C. Bjørnland & Leif Anders Thorsrud, 2019. "Commodity prices and fiscal policy design: Procyclical despite a rule," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 34(2), pages 161-180, March.
    5. Kuusi, Tero, 2018. "Does the structural budget balance guide fiscal policy pro-cyclically? Evidence from the Finnish Great Depression of the 1990s," MPRA Paper 84829, University Library of Munich, Germany.
    6. Nkrumah, Kwabena Meneabe, 2018. "Essays In Fiscal Policy And State Dependence Fiscal Policy Innovations Using A New Econometric Approach," MPRA Paper 98689, University Library of Munich, Germany.
    7. Bai, Yuting & Leeper, Eric M., 2017. "Fiscal stabilization vs. passivity," Economics Letters, Elsevier, vol. 154(C), pages 105-108.
    8. Paulo Vieira & Celsa Machado & Ana Paula Ribeiro, 2016. "Optimal Fiscal Simple Rules for Small and Large Countries of a Monetary Union," EcoMod2016 9685, EcoMod.
    9. Debrun, Xavier & Jonung, Lars, 2019. "Under threat: Rules-based fiscal policy and how to preserve it," European Journal of Political Economy, Elsevier, vol. 57(C), pages 142-157.
    10. Hans Pitlik & Michael Klien & Stefan Schiman, 2017. "Stabilitätskonforme Berücksichtigung nachhaltiger öffentlicher Investitionen," WIFO Studies, WIFO, number 60595, January.
    11. Ryota Nakatani, 2021. "Fiscal Rules for Natural Disaster- and Climate Change-Prone Small States," Sustainability, MDPI, Open Access Journal, vol. 13(6), pages 1-26, March.
    12. Musgrave, Ralph S., 2014. "The Solution is Full Reserve / 100% Reserve Banking," MPRA Paper 57955, University Library of Munich, Germany.
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    15. Ludovit Ódor & Gábor P. Kiss, 2014. "Back to basics – good indicators for good fiscal institutions!," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 13(4), pages 125-151.

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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