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Deficit Limits, Budget Rules and Fiscal Policy

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  • Paolo Manasse

    (Universita' di Bologna &IMF)

Abstract

The paper presents a simple model for discussing the effects of deficit limits and budget rules on fiscal policy. I find that limits on deficit- output ratios provide incentives to implement procyclical policies when the economy is in intermediate states, and countercyclical policies only in very “good” and very “bad” economic times. As a result, fiscal “reaction functions” are not monotonically related to the state of the economy. Deficit limits are found to exert discipline only provided the limit is tight and the expected sanction large, albeit at a relatively large welfare cost. Moreover, when fiscal choices are made under a veil of ignorance about the output gap, an increase in volatility is likely to raise the level of the budget deficit. Finally, concerning the design of fiscal frameworks, when excessive deficits arise from a political bias, deficit limits should be symmetric and not state-contingent.

Suggested Citation

  • Paolo Manasse, 2005. "Deficit Limits, Budget Rules and Fiscal Policy," Macroeconomics 0509011, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0509011 Note: Type of Document - pdf
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    File URL: http://econwpa.repec.org/eps/mac/papers/0509/0509011.pdf
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    References listed on IDEAS

    as
    1. Feldstein, Martin, 2005. "The euro and the stability pact," Journal of Policy Modeling, Elsevier, vol. 27(4), pages 421-426, June.
    2. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
    3. Torsten Persson & Gerard Roland & Guido Tabellini, 2003. "How Do Electoral Rules Shape Party Structures, Government Coalitions and Economic Policies?," Working Papers 251, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    4. Grossman, Gene M & Helpman, Elhanan, 1994. "Protection for Sale," American Economic Review, American Economic Association, pages 833-850.
    5. Bottazzi, Laura & Manasse, Paolo, 2005. "Asymmetric Information and Monetary Policy in Common Currency Areas," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(4), pages 603-621, August.
    6. Massimo Bordignon & Paolo Manasse & Guido Tabellini, 2001. "Optimal Regional Redistribution under Asymmetric Information," American Economic Review, American Economic Association, pages 709-723.
    7. Manasse, Paolo, 1996. "Are taxes too low?," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1263-1288.
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    Citations

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    Cited by:

    1. Xavier Debrun, 2006. "Tying hands is not commitment: can fiscal rules and institutions really enhance fiscal discipline?," Working Papers 48, Bruegel.
    2. Jacopo Cimadomo, 2012. "Fiscal Policy in Real Time," Scandinavian Journal of Economics, Wiley Blackwell, vol. 114(2), pages 440-465, June.
    3. Xavier Debrun & Manmohan S. Kumar, 2007. "The Discipline-Enhancing Role of Fiscal Institutions; Theory and Empirical Evidence," IMF Working Papers 07/171, International Monetary Fund.
    4. Paolo Manasse & Ugo Panizza & Laura Dos Reis, 2007. "Targeting the Structural Balance," IDB Publications (Working Papers) 1595, Inter-American Development Bank.
    5. Håvard Halland & Michael Bleaney, "undated". "Explaining The Procyclicality of Fiscal Policy in Developing Countries," Discussion Papers 11/09, University of Nottingham, CREDIT.
    6. repec:eee:ecmode:v:65:y:2017:i:c:p:138-146 is not listed on IDEAS
    7. Paolo Manasse, 2006. "Procyclical Fiscal Policy; Shocks, Rules, and Institutions: A View From Mars," IMF Working Papers 06/27, International Monetary Fund.
    8. Badinger, Harald & Reuter, Wolf Heinrich, 2015. "Measurement of fiscal rules: Introducing the application of partially ordered set (POSET) theory," Journal of Macroeconomics, Elsevier, pages 108-123.

    More about this item

    Keywords

    Fiscal Rules; SGP; Pro-cyclical Fiscal Policy;

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • 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

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