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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
Credible Forward Guidance
We analyze credible forward guidance policies in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates by solving a series of optimal sustainable policy problems indexed by the duration of reputational loss. Lower-for-longer policies---while effective in stimulating the economy at the ELB---are potentially time-inconsistent, as the associated overheating of the economy in the aftermath of a crisis is undesirable ex post. However, if reneging on a lower-for-longer promise leads to a loss of reputation and prevents the central bank from effectively using ...
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 prone to overspending. 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 ...
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 prone to overspending. 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 ...
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 is about an order of magnitude more severe than the debt bias and has a major impact on welfare ...
Working Paper
Fiscal Dominance
Central banks' resolve and independence are chronically tested by fiscal authorities wishing to impose their desired policies, often leading to socially undesirable economic outcomes. I study how the fiscal and monetary authorities' disagreement over outcomes and their choice of active instruments shape the implementation of policy, dispensing with commitment or first-mover advantage. I characterize the equilibrium for various combinations of active (and correspondingly, passive) instruments, identify which sources of disagreement play a role in each case, and show whether and under what ...
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
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
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, and yields welfare gains equivalent to 10% of consumption. Most of the benefits can still be reaped with a milder constraint or ...