DP12570 Fiscal Rules and Discretion in a World Economy

Author(s): Marina Halac, Pierre Yared
Publication Date: January 2018
Keyword(s): Asymmetric and Private Information, institutions, Macroeconomic Policy, political economy, Structure of Government
JEL(s): D02, D82, E60, H10, P16
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12570

Governments are present-biased toward spending. Fiscal rules are deficit limits that trade off commitment to not overspend and flexibility to react to shocks. We compare coordinated rules -- chosen jointly by a group of countries -- to uncoordinated rules. If governments' present bias is small, coordinated rules are tighter than uncoordinated rules: individual countries do not internalize the redistributive effect of interest rates. However, if the bias is large, coordinated rules are slacker: countries do not internalize the disciplining effect of interest rates. Surplus limits enhance welfare, and increased savings by some countries or outside economies can hurt the rest.