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Fiscal rules and discretion under persistent shocks
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Halac, Marina and Yared, Pierre (2013) Fiscal rules and discretion under persistent shocks. Working Paper. Coventry, UK: University of Warwick, Department of Economics. Warwick economics research papers series (TWERPS), Volume 2013 (Number 1014).
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Text (Working paper)
WRAP_twerp_1014_Halac.pdf Download (780Kb) | Preview |
Official URL: http://www2.warwick.ac.uk/fac/soc/economics/resear...
Abstract
This paper studies the optimal level of discretion in policymaking. We consider a fiscal policy model where the government has time-inconsistent preferences with a present-bias towards public spending. The government chooses a fiscal rule to trade off its desire to commit to not overspend against its desire to have flexibility to react to privately observed shocks to the value of spending. We analyze the optimal fiscal rule when the shocks are persistent. Unlike under i.i.d: shocks, we show that the ex-ante optimal rule is not sequentially optimal, as it provides dynamic incentives. The ex-ante optimal rule exhibits history dependence, with high shocks leading to an erosion of future fiscal discipline compared to low shocks, which lead to the reinstatement of discipline. The implied policy distortions oscillate over time given a sequence of high shocks, and can force the government to accumulate maximal debt and become immiserated in the long run.
| Item Type: | Working or Discussion Paper (Working Paper) | ||||
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| Subjects: | H Social Sciences > HB Economic Theory H Social Sciences > HG Finance H Social Sciences > HJ Public Finance |
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| Divisions: | Faculty of Social Sciences > Economics | ||||
| Library of Congress Subject Headings (LCSH): | Economics -- Mathematical models , Policy sciences, Macroeconomics -- Mathematical models , Economics | ||||
| Series Name: | Warwick economics research papers series (TWERPS) | ||||
| Publisher: | University of Warwick, Department of Economics | ||||
| Place of Publication: | Coventry, UK | ||||
| Official Date: | 2013 | ||||
| Dates: |
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| Volume: | Volume 2013 | ||||
| Number: | Number 1014 | ||||
| Number of Pages: | 55 | ||||
| Institution: | University of Warwick | ||||
| Status: | Not Peer Reviewed | ||||
| Access rights to Published version: | Open Access |
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