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Fiscal Rules and Discretion under Self-Enforcement

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  • Marina Halac
  • Pierre Yared

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.

Suggested Citation

  • Marina Halac & Pierre Yared, 2017. "Fiscal Rules and Discretion under Self-Enforcement," NBER Working Papers 23919, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:23919
    Note: EFG PE POL
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    Cited by:

    1. Mengus, Eric & Barthelemy, Jean, 2017. "Monetary Rules, Determinacy and Limited Enforcement," HEC Research Papers Series 1202, HEC Paris, revised 11 May 2019.
    2. Valerio Dotti & Eckhard Janeba, 2020. "Consistent Flexibility: Enforcement of Fiscal Rules through Political Incentives," CESifo Working Paper Series 8440, CESifo.
    3. Javier Bianchi & Pablo Ottonello & Ignacio Presno, 2023. "Fiscal Stimulus under Sovereign Risk," Journal of Political Economy, University of Chicago Press, vol. 131(9), pages 2328-2369.
    4. Barthélemy, Jean & Mengus, Eric & Plantin, Guillaume, 2024. "The central bank, the treasury, or the market: Which one determines the price level?," Journal of Economic Theory, Elsevier, vol. 220(C).
    5. Coate, Stephen & Milton, Ross T., 2019. "Optimal fiscal limits with overrides," Journal of Public Economics, Elsevier, vol. 174(C), pages 76-92.

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    More about this item

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H1 - Public Economics - - Structure and Scope of Government
    • P16 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Capitalist Institutions; Welfare State

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