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The Costs and Benefits of Balanced Budget Rules: Lessons from a Political Economy Model of Fiscal Policy

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  • Marina Azzimonti
  • Marco Battaglini
  • Stephen Coate

Abstract

This paper analyzes the impact of a balanced budget rule that requires that legislators do not run deficits in the political economy model of Battaglini and Coate (2008). The main finding is that the rule leads to a gradual reduction in the level of public debt. Legislators reduce debt in periods when the demand for public goods is relatively low. They do so because the rule, by restricting future fiscal policies, raises the expected costs of carrying debt. Whether the rule increases citizen welfare depends on a comparison of the benefits of a lower debt burden with the costs of greater volatility in taxes and less responsive public good provision. A quantitative version of the model is developed in which costs and benefits can be evaluated. A welfare loss results if the debt level when the rule is imposed lies in the support of the long-run distribution associated with the unconstrained equilibrium.
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Suggested Citation

  • Marina Azzimonti & Marco Battaglini & Stephen Coate, 2015. "The Costs and Benefits of Balanced Budget Rules: Lessons from a Political Economy Model of Fiscal Policy," Department of Economics Working Papers 15-03, Stony Brook University, Department of Economics.
  • Handle: RePEc:nys:sunysb:15-03
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    Cited by:

    1. Bouton, Laurent & Lizzeri, Alessandro & Persico, Nicola, 2016. "The Political Economy of Debt and Entitlements," CEPR Discussion Papers 11459, C.E.P.R. Discussion Papers.
    2. Marina Halac & Pierre Yared, 2015. "Fiscal Rules and Discretion in a World Economy," NBER Working Papers 21492, National Bureau of Economic Research, Inc.
    3. repec:rsr:supplm:v:65:y:2017:i:1:p:93-105 is not listed on IDEAS
    4. repec:rsr:supplm:v:65:y:2017:i:5:p:122-138 is not listed on IDEAS
    5. Holger Sieg & Daniele Coen-Pirani & Jeffrey Brinkman, 2015. "The Political Economy of Underfunded Municipal Pension Plans," 2015 Meeting Papers 345, Society for Economic Dynamics.
    6. repec:eee:jeborg:v:144:y:2017:i:c:p:133-152 is not listed on IDEAS
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    8. Tetsuo Ono, 2014. "Growth, Unemployment, and Fiscal Policy: A Political Economy Analysis," Discussion Papers in Economics and Business 14-30-Rev., Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP), revised Sep 2015.
    9. Heinemann, Friedrich & Janeba, Eckhard & Schröder, Christoph & Streif, Frank, 2016. "Fiscal rules and compliance expectations – Evidence for the German debt brake," Journal of Public Economics, Elsevier, vol. 142(C), pages 11-23.
    10. Bowen, T. Renee & Chen, Ying & Eraslan, Hülya & Zápal, Jan, 2017. "Efficiency of flexible budgetary institutions," Journal of Economic Theory, Elsevier, vol. 167(C), pages 148-176.
    11. Facundo Piguillem & Alessandro Riboni, 2018. "Fiscal Rules as Bargaining Chips," EIEF Working Papers Series 1804, Einaudi Institute for Economics and Finance (EIEF), revised Mar 2018.
    12. Marina Halac & Pierre Yared, 2017. "Fiscal Rules and Discretion under Self-Enforcement," NBER Working Papers 23919, National Bureau of Economic Research, Inc.
    13. Stanley L. Winer, 2016. "The Political Economy of Taxation: Power, Structure, Redistribution," CESifo Working Paper Series 6252, CESifo Group Munich.
    14. Tetsuo Ono & Yuki Uchida, 2018. "Political Economy of Taxation, Debt Ceilings, and Growth," Discussion Papers in Economics and Business 18-22, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
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    17. Cunha, Alexandre B. & Ornelas, Emanuel, 2017. "The Limits of Political Compromise: Debt Ceilings and Political Turnover," CEPR Discussion Papers 11945, C.E.P.R. Discussion Papers.
    18. repec:rsr:supplm:v:65:y:2017:i:6:p:154-162 is not listed on IDEAS
    19. Real Arai & Katsuyuki Naito & Tetsuo Ono, 2018. "Intergenerational policies, public debt, and economic growth: a politico{economic analysis," Discussion Papers in Economics and Business 18-12, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    20. Alberto Alesina & Andrea Passalacqua, 2015. "The Political Economy of Government Debt," NBER Working Papers 21821, National Bureau of Economic Research, Inc.
    21. repec:beo:journl:v:62:y:2017:i:212:p:7-42 is not listed on IDEAS
    22. Tetsuo Ono, 2018. "Fiscal Rules in a Monetary Economy: Implications for Growth and Welfare," Discussion Papers in Economics and Business 18-27, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    23. Karakas, Leyla D., 2016. "Political turnover and the accumulation of democratic capital," European Journal of Political Economy, Elsevier, vol. 44(C), pages 195-213.

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