How to Starve the Beast: Fiscal Policy Rules

Martin, Fernando M.

doi:10.20955/wp.2019.026

Working Paper Revision

How to Starve the Beast: Fiscal Policy Rules

Abstract: Countries have widely imposed fiscal rules designed to constrain government spending and ensure fiscal responsibility. This paper studies the effectiveness and welfare implications of expenditure, revenue, budget balance and debt rules when governments are discretionary and prone to overspending. The optimal prescription is either an expenditure ceiling or a combination of revenue and primary deficit ceilings. Most of the benefits can still be reaped with constraints looser than optimal or escape clauses during adverse times. When imposed on their own, revenue ceilings are only mildly effective, while budget and debt rules are altogether ineffective.

Keywords: fiscal rules; discretion; time-consistency; government debt; deficit; institutional design; political frictions; austerity; debt sustainability;

JEL Classification: E52; E58; E61; E62;

https://doi.org/10.20955/wp.2019.026