Deficit Limits, Budget Rules and Fiscal Policy

Abstract

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.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. JEL Classification Numbers: E60, E61, E62

Single Currency in ECOWAS: Is the Proposed Fiscal Convergence Criterion Pro‐Growth?

“…It is why ECOWAS countries have defined currently a fiscal norm limiting the public deficit as a fiscal convergence criterion for the future monetary union. Theoretically, the definition of a convergence criterion limiting the public deficit allows to establish more fiscal discipline, to support economic growth, to facilitate economic convergence and to increase the capacity of economic resilience of countries (Adam and Bevan, ; Manasse, ). According to Buti et al (), fiscal discipline is very important for the formation, the viability, and the credibility of a monetary union.…”

Propuesta y diseño de una regla fiscal genérica

“…Por el contrario, también existe la posibilidad de que el comportamiento del sector público tienda a ser procíclico, por lo que imponerle límites puede mitigar un factor adicional de volatilidad (Buchanan, 1997, 127-129;Debrun et al, 2008: 302-303;Alesina y Bayoumi, 1996). Incluso otros autores llegan a la conclusión de que las reglas no solo mejoran el resultado fiscal, sino que también reducen la volatilidad macroeconómica, negando la existencia del trade-off (Ayuso-i-Casals et al, 2006: 687-691;Manasse, 2005Manasse, y 2006. Por su parte, Fatás y Mihov (2005) reconocen que la introducción de restricciones, por un lado, limita la respuesta de la política fiscal ante shocks exógenos, aumentando la volatilidad.…”

Targeting the Structural Balance

“…In a simple Barro-Gordon framework, Manasse (2005) rationalizes the idea that deficitto-GDP limits, involving a linear (stochastic) penalty when breached, entail a trade-off between the benefits of reducing the average deficit bias, which is assumed to be politically motivated, and the costs of foregone stabilization (to which the expected penalty must be added when the stabilization requires a violation of the limit). As a result of the fiscal constraint, the optimal policy becomes state-contingent: in moderately bad times, the constraint is reached and the government optimally chooses to keep the deficit-to-GDP ratio as close as possible to the limit in order to avoid the penalty (fiscal policy is "acyclical").…”