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The Welfare and Stabilization Benefits of Fiscal Rules: Evidence from Canadian Provinces

Author

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  • Landon, Stuart

    () (University of Alberta, Department of Economics)

  • Smith, Constance

    () (University of Alberta, Department of Economics)

Abstract

The growth of debt and deficits in developed countries has led many states to consider the adoption of fiscal rules. There is little evidence on the benefits of different types of rules. This study uses Monte Carlo techniques to examine the impact on welfare and government spending stabilization of five types of government expenditure rules. The simulation employs a three-variable VAR estimated using data for the Canadian provinces. The use of a VAR captures the interactive effects between spending under the fiscal rule, output and revenue. The best fiscal rules reduce government expenditure volatility by about half relative to a balanced budget rule. The stabilization benefit is about twice as great for the three provinces with more resource-based and volatile revenue — Alberta, Saskatchewan and Newfoundland. Some fiscal rules lead to an unsustainable path for government debt or assets under many simulations due to an absence of feedback from the stock of debt or assets to current expenditure. We find that a simple rule, where government expenditure is based on the moving average of past government revenue, is one of the better performing rules and yields a level of expenditure stabilization and a welfare gain similar to the more complicated “debt brake” rule adopted by Switzerland and other countries. The Swiss rule requires forecasts for revenue and output, and its greater complexity may make it more difficult to implement, monitor, and communicate to the public.

Suggested Citation

  • Landon, Stuart & Smith, Constance, 2015. "The Welfare and Stabilization Benefits of Fiscal Rules: Evidence from Canadian Provinces," Working Papers 2015-13, University of Alberta, Department of Economics.
  • Handle: RePEc:ris:albaec:2015_013
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    File URL: https://sites.ualberta.ca/~econwps/2015/wp2015-13.pdf
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    References listed on IDEAS

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    1. Oya Celasun & Xavier Debrun & Jonathan D. Ostry, 2006. "Primary Surplus Behavior and Risks to Fiscal Sustainability in Emerging Market Countries: A "Fan-Chart" Approach," IMF Staff Papers, Palgrave Macmillan, vol. 53(3), pages 1-3.
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    3. Mise, Emi & Kim, Tae-Hwan & Newbold, Paul, 2005. "On suboptimality of the Hodrick-Prescott filter at time series endpoints," Journal of Macroeconomics, Elsevier, vol. 27(1), pages 53-67, March.
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    5. Iara, Anna & Wolff, Guntram B., 2014. "Rules and risk in the Euro area," European Journal of Political Economy, Elsevier, vol. 34(C), pages 222-236.
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    More about this item

    Keywords

    fiscal rules; fiscal policy; stabilization; government spending; Canadian government; economic policy;

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H61 - Public Economics - - National Budget, Deficit, and Debt - - - Budget; Budget Systems
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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