Working Paper: CEPR ID: DP14682
Authors: Facundo Piguillem; Alessandro Riboni
Abstract: Most fiscal rules can be overridden by consensus. We show that this does not make them ineffectual. Since fiscal rules determine the outside option in case of disagreement, the opposition uses them as ``bargaining chips" to obtain spending concessions. We show that under some conditions this political bargain mitigates the debt accumulation problem. We analyze various rules and find that when political polarization is high, harsh fiscal rules (e.g., government shutdown) maximize the opposition's bargaining power and leads to lower debt accumulation. When polarization is low, less strict fiscal limits (e.g, balanced-budget rule) are preferable. Moreover, we find that the optimal fiscal rules could arise in equilibrium by negotiation. Finally, by insuring against power fluctuations, negotiable rules yield higher welfare than strict ones.
Keywords: Fiscal Rules; Government Debt; Legislative Bargaining; Political Polarization; Government Shutdown
JEL Codes: H2; H6; D72
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fiscal rules (E62) | outside option in case of disagreement (C78) |
| fiscal rules (E62) | bargaining chips (C78) |
| negotiable fiscal rules (E62) | limit large debt buildups (F65) |
| certain fiscal rules (E62) | favor interparty compromise (D72) |
| certain fiscal rules (E62) | reduce debt accumulation (H63) |
| high political polarization + strict fiscal rules (E62) | enhance opposition's bargaining power (D74) |
| low political polarization + less stringent fiscal rules (E62) | more effective (C90) |
| negotiable fiscal rules (E62) | yield higher welfare (D69) |
| political bargain (D72) | more spending (H59) |
| political bargain (D72) | reduce debt accumulation (H63) |
| anticipated future bargaining dynamics (J52) | shape outcomes (I24) |