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Working Paper
How to Starve the Beast: Fiscal and Monetary Policy Rules
Societies often rely on simple rules to restrict the size and behavior of governments. When fiscal and monetary policies are conducted by a discretionary and profligate government, I find that revenue ceilings vastly outperform debt, deficit and monetary rules, both in effectiveness at curbing public spending and welfare for private agents. However, effective revenue ceilings induce an increase in deficit, debt and inflation. Under many scenarios, including recurrent adverse shocks, the optimal ceiling on U.S. federal revenue is about 15% of GDP, which leads to welfare gains for private ...
Working Paper
How to Starve the Beast: Fiscal Policy Rules
Countries have widely imposed fiscal rules designed to constrain government spending and ensure fiscal responsibility. This paper studies the effectiveness and welfare implications of revenue, deficit and debt rules when governments are discretionary and profligate. The optimal prescription is a revenue ceiling coupled with a balance budget requirement. For the U.S., the optimal revenue ceiling is about 15% of output, 3 percentage points below the postwar average. Most of the benefits can still be reaped with a milder constraint or escape clauses during adverse times. Imposing a single fiscal ...
Working Paper
Fiscal Dominance
Who prevails when fiscal and monetary authorities disagree about the value of public expenditure and how much to discount the future? When the fiscal authority sets debt as its main policy instrument it achieves fiscal dominance, rendering the preferences of the central bank, and thus its independence, irrelevant. When the central bank sets the nominal interest rate it renders fiscal impatience (its debt bias) irrelevant, but still faces its expenditure bias. I find that the expenditure bias has a major impact on welfare through higher public spending, while the effect on other policies is ...
Working Paper
Policy Rules and Large Crises in Emerging Markets
Emerging countries have increasingly adopted rules to discipline government policy. The COVID-19 shock lead to widespread suspension and modification of these rules. We study rules and flexibility in a sovereign default model with domestic fiscal and monetary policies and long-term external debt. We find welfare gains from adopting monetary targets and debt limits during normal times. Though government policy cannot itself counteract fundamental shocks hitting the economy, the adoption of rules has a significant impact on policy, macroeconomic outcomes and welfare during large, unexpected ...
Working Paper
Policy Rules and Large Crises in Emerging Markets
Emerging economies have adopted fiscal and monetary rules to discipline government policy. We study the value and macroeconomic implications of rules and flexibility within a sovereign-default model that incorporates domestic fiscal and monetary policies and long-term external debt. Adopting monetary targets and debt limits during normal times yields welfare gains. Suspending rules can significantly influence policy, macroeconomic outcomes, and welfare during large, unforeseen crises. The gains from flexibility depend on how quickly policymakers are able to reimpose rules after the crisis.
Working Paper
The Value of Constraints on Discretionary Government Policy
This paper investigates how institutional constraints discipline the behavior of discretionary governments subject to an expenditure bias. The focus is on constraints implemented in actual economies: monetary policy targets, limits on the deficit and debt ceilings. For a variety of aggregate shocks considered, the best policy is to impose a minimum primary surplus of about half a percent of output. Most welfare gains from constraining government behavior during normal times, which to a large extent is sufficient to discipline policy in adverse times. Monetary policy targets are not generally ...
Working Paper
Policy Rules and Large Crises in Emerging Markets
Emerging economies have adopted fiscal and monetary rules to discipline government policy. We study the value and macroeconomic implications of rules and flexibility within a sovereign-default model that incorporates domestic fiscal and monetary policies and long-term external debt. Adopting monetary targets and debt limits during normal times yields welfare gains. Suspending rules can significantly influence policy, macroeconomic outcomes, and welfare during large, unforeseen crises. The gains from flexibility depend on how quickly policymakers are able to reimpose rules after the crisis.
Working Paper
How to Starve the Beast: Fiscal Policy Rules
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 ...
Working Paper
How to Starve the Beast: Fiscal Policy Rules
Countries have widely imposed fiscal rules designed to constrain government spending and ensure fiscal responsibility. This paper studies the effectiveness and welfare implications of revenue, deficit and debt rules when governments are discretionary and profligate. The optimal prescription is a revenue ceiling coupled with a balance budget requirement. For the U.S., the optimal revenue ceiling is about 15% of output, 3 percentage points below the postwar average. Most of the benefits can still be reaped with a milder constraint or escape clauses during adverse times. Imposing a single fiscal ...
Working Paper
Solving for Optimal Simple Rules in Rational-Expectations Models
This paper presents techniques to solve for optimal simple monetary policy rules in rational expectations models, assuming discretion. The techniques described are notable for the flexibility they provide over the structure of the policy rule being solved for. Specifically, not all state variables need enter the policy rule allowing rules optimal conditional on a given information set to be easily constructed. The algorithms described are compared to related solution methods, and applied to the model in Clarida, Gali, and Gertler (1999).