Research Discussion Papers, Bank of Finland
No 1/2004:
Stability consequences of fiscal policy rules
Jukka Railavo ()
Abstract: Using an optimisation-based model with endogenous labour
supply and a proportional tax rate, we compare the stabilising properties
of different fiscal policy rules. The economy is affected by shocks from
both government spending and technology. The fiscal policy rule can be
based on government liabilities or the government budget deficit. As both
are given as measures of fiscal policy performance in the Stability and
Growth Pact (SGP), we also use a fiscal policy rule based on the
combination of the two. We compare the accounting definition of deficit
with the economic definition which takes inflation into account. The fiscal
policy rule based on debt, with monetary policy consistent with the Taylor
principle, results in an unstable solution. However, a fiscal policy rule
based on deficit produces stable solutions with a wide range of fiscal
policy parameters. Moreover, we find that putting more weight on the
deficit than the debt in the fiscal policy rule creates less cyclical
responses to shocks. Finally we find out that the SGP definition of deficit
performs as well as the real deficit based on the government budget
constraint.
Keywords: inflation; fiscal and monetary policy; stabilisation; (follow links to similar papers)
JEL-Codes: E31; E52; E61; (follow links to similar papers)
45 pages, January 20, 2004
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