The Value of Constraints on Discretionary Government Policy

This paper provides a systematic study of constraints on policy designed to curb the behavior of undisciplined governments: monetary policy targets, limits on the deficit and debt ceilings. For a variety of aggregate shocks... [ view full abstract ]

This paper provides a systematic study of constraints on policy designed to curb the behavior of undisciplined governments: monetary policy targets, limits on the deficit and debt ceilings. For a variety of aggregate shocks considered, the best policy is to impose a minimum primary surplus of about half a percent of output. Most welfare gains arise from constraining government behavior during normal times, which to a large extent is sufficient to discipline policy in adverse times. Monetary policy targets are not generally desirable as they hinder the ability of governments to smooth distortions. Allowing for the effective use of inflation during transitions is a key component of good institutional design. Debt ceilings are benign, but always dominated by deficit constraints.