DP14682 Fiscal Rules as Bargaining Chips

Author(s): Facundo Piguillem, Alessandro Riboni
Publication Date: April 2020
Keyword(s): fiscal rules, Government Debt, Government shutdown=, legislative bargaining, Political Polarization
JEL(s): D72, H2, H6
Programme Areas: Public Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14682

Most fiscal rules can be overridden by consensus. We show that this does not make them ineffectual. Since fiscal rules determine the outside option in case of disagreement, the opposition uses them as ``bargaining chips" to obtain spending concessions. We show that under some conditions this political bargain mitigates the debt accumulation problem. We analyze various rules and find that when political polarization is high, harsh fiscal rules (e.g., government shutdown) maximize the opposition's bargaining power and leads to lower debt accumulation. When polarization is low, less strict fiscal limits (e.g, balanced-budget rule) are preferable. Moreover, we find that the optimal fiscal rules could arise in equilibrium by negotiation. Finally, by insuring against power fluctuations, negotiable rules yield higher welfare than strict ones.