Fiscal Fluctuation Risks and Intergovernmental Functional Allocation

To cope with business cycle risks, a government has several fiscal measures at its disposal. First, the government may reduce the economic cost of recession. Second, the government may stimulate GDP in a recession. Furthermore, it is also useful to maintain a boom as long as possible. For each policy option, the government can use both automatic stabilizers and discretionary fiscal policy. Automatic stabilizers prepare business fluctuation risks in advance as a part of fiscal systems. At the same time, it is sometimes necessary for the government to use discretionary fiscal policy to cope with a serious recession. In terms of intergovernmental financing, local governments should play a major role, as well as central government. If both informational asymmetry and regional heterogeneity are relevant, local governments have a comparative advantage on discretionary social welfare programs. In order to maintain the sustainability of such measures, the government has to ensure the sustainability of the fiscal system. In this sense, it might be an important measure to build an automatic fiscal stabilizing mechanism into the budgetary system, which would reduce spending and raise revenues automatically when fiscal deficit accumulates.