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Stability consequences of fiscal policy rules

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  • Jukka Railavo

    (Bank of Finland)

Abstract

Using an optimisation-based model with endogenous labour supply and a proportional tax rate, we compare the stabilising properties of different fiscal policy rules. The economy is affected by shocks from both government spending and technology. The fiscal policy rule can be based on government liabilities or the government budget deficit. As both are given as measures of fiscal policy performance in the Stability and Growth Pact (SGP), we also use a fiscal policy rule based on the combination of the two. We compare the accounting definition of deficit with the economic definition which takes inflation into account. The fiscal policy rule based on debt, with monetary policy consistent with the Taylor principle, results in an unstable solution. However, a fiscal policy rule based on deficit produces stable solutions with a wide range of fiscal policy parameters. Moreover, we find that putting more weight on the deficit than the debt in the fiscal policy rule creates less cyclical responses to shocks. Finally we find out that the SGP definition of deficit performs as well as the real deficit based on the government budget constraint.

Suggested Citation

  • Jukka Railavo, 2004. "Stability consequences of fiscal policy rules," Macroeconomics 0404020, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0404020
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Marattin, Luigi & Marzo, Massimiliano & Zagaglia, Paolo, 2011. "A welfare perspective on the fiscal–monetary policy mix: The role of alternative fiscal instruments," Journal of Policy Modeling, Elsevier, vol. 33(6), pages 920-952.
    2. Javier Andrés & Rafael Doménech, 2006. "Fiscal Rules and Macroeconomic Stability," Hacienda Pública Española, IEF, vol. 176(1), pages 9-41, April.
    3. Jukka Railavo, 2005. "Monetary Concequences of Alternative Fiscal Policy Rules," Computing in Economics and Finance 2005 145, Society for Computational Economics.
    4. Kremer, Jana, 2004. "Fiscal rules and monetary policy in a dynamic stochastic general equilibrium model," Discussion Paper Series 1: Economic Studies 2004,35, Deutsche Bundesbank.
    5. Kilponen, Juha & Kinnunen, Helvi & Ripatti, Antti, 2006. "Population ageing in a small open economy : some policy experiments with a tractable general equilibrium model," Research Discussion Papers 28/2006, Bank of Finland.
    6. Railavo, Jukka, 2004. "Monetary consequences of alternative fiscal policy rules," Research Discussion Papers 20/2004, Bank of Finland.

    More about this item

    Keywords

    inflation; fiscal and monetary policy; stabilisation;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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