Implications of fiscal constraints

Recent events in the U.S. and Europe have renewed interest in the desirability of imposing constraints on fiscal policy. In the U.S., the implementation of large and persistent deficits as a response to the financial crisis and subsequent recession motivated debates about debt ceilings and brought back proposals for balanced-budget-rules. In the Eurozone, the fiscal crisis driven by excessive debt has forced some governments to enact austerity programs, consisting both of tax increases and expenditure cuts. The objective of this paper is to evaluate the effects of putting constraints on the ability of politicians to run fiscal policy, with an emphasis on how monetary policy interacts with such restrictions. The institutional experiments conducted include balanced budget rules and cooperation between government agencies in setting policy.