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Fiscal rules and discretion under persistent shocks
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Halac, Marina and Yared, Pierre (2014) Fiscal rules and discretion under persistent shocks. Econometrica, Volume 82 (Number 5). pp. 1557-1614. doi:10.3982/ECTA11207 ISSN 0012-9682.
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Official URL: http://dx.doi.org/10.3982/ECTA11207
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 toward 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 independent and identically distributed 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: | Journal Article | ||||||||
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Divisions: | Faculty of Social Sciences > Economics | ||||||||
Journal or Publication Title: | Econometrica | ||||||||
Publisher: | Blackwell Publishing | ||||||||
ISSN: | 0012-9682 | ||||||||
Official Date: | September 2014 | ||||||||
Dates: |
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Volume: | Volume 82 | ||||||||
Number: | Number 5 | ||||||||
Page Range: | pp. 1557-1614 | ||||||||
DOI: | 10.3982/ECTA11207 | ||||||||
Status: | Peer Reviewed | ||||||||
Publication Status: | Published | ||||||||
Access rights to Published version: | Restricted or Subscription Access | ||||||||
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