DP12570 | Fiscal Rules and Discretion in a World Economy

Publication Date

01/05/2018

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Abstract

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.