Philippe Michel, Leopold Von Thadden, and Jean-Pierre Vidal, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt/Main, Germany (leopold.von_thadden ecb.europa.eu).
Debt Stabilizing Fiscal Rules
Article first published online: 7 SEP 2010
© 2010 Wiley Periodicals, Inc.
Journal of Public Economic Theory
Volume 12, Issue 5, pages 923–941, October 2010
How to Cite
MICHEL, P., VON THADDEN, L. and VIDAL, J.-P. (2010), Debt Stabilizing Fiscal Rules. Journal of Public Economic Theory, 12: 923–941. doi: 10.1111/j.1467-9779.2010.01480.x
We thank Roel Beetsma, Andrew Hughes Hallett, Luisa Lambertini, Eric Leeper, José Marin, Efraim Sadka, Andreas Schabert, as well as seminar participants at the ECB, the CEPR-conference on “Labor Markets, Fiscal Policy and Structural Reform” (Copenhagen, 2005), the ZEI/CfS-conference on “New perspectives on Fiscal Sustainability” (Frankfurt, 2005), and at the 2005 annual meetings of the Society for Computational Economics (Washington), the Public Economic Theory 2005 Meeting (Marseille), the European Economic Association (Amsterdam), the International Institute of Public Finance (Jeju Island, Korea), the German Economic Association (Bonn), and the Latin American and Caribbean Economic Association (Paris) for helpful comments. Moreover, this paper has benefited from detailed comments by two anonymous referees. The views expressed in this paper are those of the authors and do not necessarily reflect those of the ECB. This paper was started during Philippe Michel's visit at the ECB in June 2004.
- Issue published online: 7 SEP 2010
- Article first published online: 7 SEP 2010
- Received December 28, 2006; Accepted December 22, 2009.
Unstable government debt dynamics can typically be stabilized around a certain target level of debt by adjustments in various fiscal instruments, like government spending, transfers, or taxes. This paper investigates properties of debt stabilizing rules which link the needed budgetary adjustments to the state of the economy. The paper establishes that the magnitude of the target level of long-run debt is a key determinant of whether it is possible to find a rule of this type that can be implemented under all available fiscal instruments. Specifically, considering linear feedback rules, the paper demonstrates that there may well exist a critical target level of debt beyond which this is no longer possible. From an applied perspective, this finding is of particular relevance in the context of a monetary union with decentralized fiscal policies. Depending on the target level of debt, there might be a conflict between a common fiscal framework that tracks deficit developments as a function of the state of the economy and the unrestricted choice of fiscal policy instruments at the national level.