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Risk Assessment Under a Non-linear Fiscal Rule

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  • Christos Shiamptanis

    (Department of Economics, Ryerson University, Toronto, Canada)

Abstract

In the aftermath of the recent financial crisis and recession, governments' actions around the world suggest a non-linear responsiveness of fiscal policy to debt. Additionally, governments are realizing that they face fiscal limits on the size of debt that they can repay. The fiscal limits arise due to distortionary taxation and political will. This paper explores the implications of a non-linear fiscal rule coupled with fiscal limits on solvency crisis. We derive the restrictions on the non-linear fiscal rule necessary to eliminate explosive behavior. We show that the marginal response of primary surplus to debt should be larger than the interest rate times an adjustment factor for the persistence in the primary surplus. However, a non-linear fiscal rule which eliminates explosive behavior can still experience a solvency crisis because of stochastic shocks. We derive the dynamics in the run-up to a solvency crisis and find that a non-linear fiscal rule can reduce the probability of solvency crisis.

Suggested Citation

  • Christos Shiamptanis, 2012. "Risk Assessment Under a Non-linear Fiscal Rule," Working Papers 038, Toronto Metropolitan University, Department of Economics.
    • Handle: RePEc:rye:wpaper:wp038
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    References listed on IDEAS

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    More about this item

    Keywords

    Non-linear fiscal rule; Fiscal Sustainability; Solvency Crisis; Policy Switching; Canada;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • 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
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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