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RESEARCH PRODUCT

Fiscal Rules and Macroeconomic Stability

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In this paper we analyze the impact of fiscal rules on the effectiveness of fiscal policy as a macroeconomic stabilizing instrument. First, we review the available evidence on the effects of fiscal policy to affect output in the short run and real interest rates and investment and growth in the long run, and we show how the use of fiscal rules has proved useful in restraining debt and deficits. Secondly, we discuss if debt consolidation rules trade off higher output instability in exchange for lower deficits, using three alternative representations of the intertemporal substitution mechanism in a SDGE framework. Our main conclusion is that both the impact of discretionary fiscal policy and the strength of automatic stabilizers are largely unaffected by the 'tightness' of these rules. Therefore, there is nothing in the design of fiscal rules aimed at preventing huge and long-lasting deviations of debt from the steady state level, which makes them an impediment to fiscal policy carrying out its job as a significant stabilizing policy instrument.