The Costs and Benefits of Balanced Budget Rules: Lessons from a Political Economy Model of Fiscal Policy
This paper analyzes the impact of a balanced budget rule that requires that legislators do not run deficits in the political economy model of Battaglini and Coate (2008). It considers both a strict rule which cannot be circumvented and a rule that can be overridden by a super-majority of legislators. A strict rule leads to a gradual but substantial reduction in the level of public debt. In the short run, citizens will be worse off as public spending is reduced and taxes are raised to bring down debt. In the long run, the benefits of a lower debt burden must be weighed against the costs of greater volatility in taxes and less responsive public good provision. In a quantitative version of the model, the long run net benefits are positive but are outweighed by the short run costs. A rule with a super-majority override has no effect on citizen welfare or fiscal policy