Fiscal Rules and Discretion Under Self-Enforcement

57 Pages Posted: 4 Oct 2017

See all articles by Marina Halac

Marina Halac

Columbia Business School - Finance and Economics

Pierre Yared

Columbia Business School - Finance and Economics

Date Written: October 2, 2017

Abstract

We study a fiscal policy model in which the government is present-biased towards public spending. Society chooses a fiscal rule to trade off the benefit of committing the government to not overspend against the benefit of granting it flexibility to react to privately observed shocks to the value of spending. Unlike prior work, we characterize rules that are self-enforcing: the government must prefer to comply with the rule rather than face the punishment that follows a breach, where any such punishment must also be self-enforcing. We show that the optimal rule is a maximally enforced deficit limit, which, if violated, leads to the worst punishment for the government. We provide a necessary and sufficient condition for the government to violate the deficit limit following sufficiently high shocks. Punishment takes the form of a maximally enforced surplus limit that incentivizes overspending; fiscal discipline is restored when the government respects it.

Keywords: Self-Enforcing Rules, Private Information, Fiscal Policy, Deficit Bias

JEL Classification: C73, D02, D82, E6, H1, P16

Suggested Citation

Halac, Marina and Yared, Pierre, Fiscal Rules and Discretion Under Self-Enforcement (October 2, 2017). Columbia Business School Research Paper No. 17-98. Available at SSRN: https://ssrn.com/abstract=3046807 or http://dx.doi.org/10.2139/ssrn.3046807

Marina Halac

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Pierre Yared (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
15
Abstract Views
292
PlumX Metrics