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Fiscal Policy and Budget Deficit Stability in a Continuous Time Stochastic Economy

  • Amador, Joao L. M.

This paper models the role of the fiscal policy and the behaviour of the budget deficit in a continuous time stochastic economy. The model is developed in a general equilibrium framework, integrating the optimisation behaviour of representative consumer and the intertemporal resource constraint of the fiscal authority. The main features of the model are the endogenous determination of the budget deficit as a percentage of deterministic output, the endogenous determination of the public bonds interest rate and the analysis of how changes in the structural and stochastic parameters affect the stationary equilibrium. In this context, we obtain conditions for the stability of the budget deficit. Finally, the paper simulates different scenarios and plots the stationary equilibrium path of the variables. The paper concludes that changes in the structural parameters of the model lead to unsustainable budget deficit behaviour. On the contrary, short-run shocks on technology and public expenditure are consistent with the stationary equilibrium. In addition, it is shown that the stationary equilibrium in economies having low tax rates and high public spending must be associated with a low public debt-wealth ratio and a low budget deficit. The same is true for economies that face high volatility in technology and expenditure shocks.

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Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp384.

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Length: 43 pages
Date of creation: 2000
Date of revision:
Handle: RePEc:unl:unlfep:wp384
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  1. Stephen J. Turnovsky, 1997. "International Macroeconomic Dynamics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262201119, June.
  2. Alesina, Alberto & Perotti, Roberto, 1996. "Fiscal Discipline and the Budget Process," American Economic Review, American Economic Association, vol. 86(2), pages 401-07, May.
  3. Barro, Robert J, 1989. "The Ricardian Approach to Budget Deficits," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 37-54, Spring.
  4. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  5. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  6. Torres,Francisco & Giavazzi,Francesco (ed.), 1993. "Adjustment and Growth in the European Monetary Union," Cambridge Books, Cambridge University Press, number 9780521440196.
  7. James M. Poterba, 1996. "Budget Institutions and Fiscal Policy in the U.S. States," NBER Working Papers 5449, National Bureau of Economic Research, Inc.
  8. Søren Bo Nielsen, 1991. "A Note on the Sustainability of Primary Budget Deficits," Discussion Papers 91-03, University of Copenhagen. Department of Economics.
  9. Francesco P. Mongelli, 1996. "The Effects of the European Economic and Monetary Union (EMU)on National Fiscal Sustainability," IMF Working Papers 96/72, International Monetary Fund.
  10. Corsetti, Giancarlo, 1997. "A portfolio approach to endogenous growth: equilibrium and optimal policy," Journal of Economic Dynamics and Control, Elsevier, vol. 21(10), pages 1627-1644, August.
  11. Kenen,Peter B., 1995. "Economic and Monetary Union in Europe," Cambridge Books, Cambridge University Press, number 9780521558839.
  12. Emerson, Michael & Gros, Daniel & Italianer, Alexander & ,, 1992. "One Market, One Money: An Evaluation of the Potential Benefits and Costs of Forming an Economic and Monetary Union," OUP Catalogue, Oxford University Press, number 9780198773245.
  13. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, June.
  14. Eichengreen, Barry, 1993. "European Monetary Unification," Journal of Economic Literature, American Economic Association, vol. 31(3), pages 1321-57, September.
  15. Perotti, Roberto & Strauch, Rolf & von Hagen, Jürgen, 1997. "Sustainability of Public Finances," CEPR Discussion Papers 1781, C.E.P.R. Discussion Papers.
  16. Bohn, H., 1990. "The Sutainability Of Budget Deficits In A Stochastic Economy," Weiss Center Working Papers 6-90, Wharton School - Weiss Center for International Financial Research.
  17. Alberto Alesina & Roberto Perotti, 1994. "The Political Economy of Budget Deficits," NBER Working Papers 4637, National Bureau of Economic Research, Inc.
  18. Bernheim, B Douglas, 1989. "A Neoclassical Perspective on Budget Deficits," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 55-72, Spring.
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