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The Macroeconomic Effects of Fiscal Rules in the US States

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  • Fatás, Antonio
  • Mihov, Ilian

Abstract

Fiscal policy restrictions are often criticized for limiting the ability of governments to react to business cycle fluctuations. Therefore, the adoption of quantitative restrictions is viewed as inevitably leading to increased macroeconomic volatility. In this Paper we use data from 48 US states to investigate how budget rules affect fiscal policy outcomes. Our key findings are that (1) strict budgetary restrictions lead to lower policy volatility (i.e. less discretion in conducting fiscal policy); and (2) fiscal restrictions reduce the responsiveness of fiscal policy to output shocks and decrease the persistence of spending fluctuations. These two results should have opposite effects on output volatility. While less discretion should reduce volatility, less responsiveness of fiscal policy might amplify business cycle volatility. Our analysis shows that the first effect dominates and that restrictions on fiscal policy lead to less volatility in output.

Suggested Citation

  • Fatás, Antonio & Mihov, Ilian, 2004. "The Macroeconomic Effects of Fiscal Rules in the US States," CEPR Discussion Papers 4372, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4372
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    Keywords

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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