Deficit Limits, Budget Rules, and Fiscal Policy

June 1, 2005

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Format: Chicago

Paolo Manasse. Deficit Limits, Budget Rules, and Fiscal Policy, (USA: International Monetary Fund, 2005) accessed September 20, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Budget planning and preparation, Fiscal policy, Fiscal rules, Government debt management, Output gap

Keywords: Budget deficit, WP

Publication Details

Pages:

19
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2005/120
Stock No:

WPIEA2005120
ISBN:

9781451861396
ISSN:

1018-5941

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