Journal Of The Econometric Society

An International Society for the Advancement of Economic
Theory in its Relation to Statistics and Mathematics

Edited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262

Econometrica: Sep, 2022, Volume 90, Issue 5

Fiscal Rules and Discretion under Limited Enforcement
p. 2093-2127

Marina Halac, Pierre Yared

We study a fiscal policy model in which the government is present‐biased towards public spending. Society chooses a fiscal rule to trade off the benefit of committing the government to not overspend against the benefit of granting it flexibility to react to privately observed shocks to the value of spending. Unlike prior work, we examine rules under limited enforcement: the government has full policy discretion and can only be incentivized to comply with a rule via the use of penalties which are joint and bounded. We show that optimal incentives must be bang‐bang. Moreover, under a distributional condition, the optimal rule is a maximally enforced deficit limit, triggering the maximum feasible penalty whenever violated. Violation optimally occurs under high enough shocks if and only if available penalties are weak and such shocks are relatively unlikely. We derive comparative statics showing how rules should be calibrated to features of the environment.

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Supplemental Material

Supplement to "Fiscal Rules and Discretion under Limited Enforcement"

Halac, Marina, and Pierre Yared

This online appendix contains material not found within the manuscript.