The Golden Rule of Public Finance: A Panacea?

Year 2012, Volume: 1 Issue: 2, 1 - 20, 01.05.2012

Mustafa İsmihan F. Gülçin Özkan

Abstract

The fiscal stimulus packages that were put in place in the wake of the recent global financial crisis consisted of massive public investment spending. Moreover, substantial increases in public debt levels in the aftermath of the crisis have highlighted the importance of fiscal discipline and thus the appropriate form of fiscal policy regimes. Motivated by these experiences, this paper provides a comparative assessment of two fiscal regimes: a balanced budget rule with tax finance and a golden rule with debt finance, with special reference to the level and the efficiency of public investment. We find that, although the golden rule is likely to be more public investment-friendly, adopting a golden rule rather than a balanced-budget rule does not guarantee that public investment will improve economic outcomes. Our results suggest that only when the rate of return on public capital is greater than the cost of public borrowing expansion of public investment beneficial. As such, we argue
that policymakers should prioritize the productivity of public investment, not just its level.

Keywords

Public investment, public debt, golden rule, balanced budget rule

References

• Balassone, F. & Franco D. (2000), “Public Investment, the Stability Pact and the ‘Golden Rule’ ”, Fiscal Studies, 21, pp. 207-229.
• Beetsma, R. & Bovenberg, L. (1999), “Does Monetary Unification Lead to Excessive Debt Accumulation?”, Journal of Public Economics, 74, pp. 299-325.
• Bénassy-Quéré, A. & Ribeiro, M. P. (2009), “Bad Weather for the Stability and Growth Pact”, La Lettre du CEPII, No. 286.
• Blanchard, O. J. & Giavazzi, F. (2004), “Improving the SGP Through a Proper Accounting of Public Investment”, CEPR Discussion Paper, No. 4220.
• Buiter, W. H. (2001), “Notes on ‘A Code for Fiscal Stability’ ”, Oxford Economic Papers, 53, pp. 1-19.
• Creel, J. & Farvaque, E. (2009), “Political Economy of Balanced-Budget Rules”, OFCE Working Paper, No. 2009-06.
• De Grauwe, P. (2011), “A Less Punishing, More Forgiving Approach to the Debt Crisis in the Eurozone”, CEPS Policy Brief, No. 230.
• De Haan, J, Sturm, J. E. & Sikken, B. J. (1996), “Government Capital Formation: Explaining the Decline”, Weltwirtschaftliches Archiv, 132, pp. 55-74.
• ECOFIN Council (2005), Specifications on the Implementation of the Stability and Growth Pact and Guidelines on the Format and Content of the Stability and Convergence Programmes, Code of Conduct, ECOFIN Council. http://ec.europa.eu/economy_finance/about /activities/sgp/codeofconduct_en.pdf. Accessed 10 December 2009.
• Fitoussi, J.P. & Creel, J. (2002), How to Reform the European Central Bank, London: Center for European Reform.
• Ghosh, S. & Nolan, C. (2007), “The Impact of Simple Fiscal Rules in Growth Models With Public Goods and Congestion”, Manchester School, 75, pp. 634-651.
• Hemming, R. & Ter-minassian, T. (2004), “Making Room for Public Investment: Possible New Approaches to Fiscal Accounting”, Finance and Development, December Issue, pp. 30-34.
• İsmihan, M. & Özkan, F.G. (2004), “Does Central Bank Independence Lower Inflation?”, Economics Letters, 84, pp. 305-309.
• İsmihan, M. & Özkan, F.G. (2011), “A Note on Public Investment, Public Debt and Macroeconomic Performance”, Macroeconomic Dynamics, 15, pp. 265-278.
• Özkan, F.G., Kipici, A. and Đsmihan, M. (2010), “The Banking Sector, Government Bonds and Financial Intermediation: The Case of Emerging Market Countries”, Emerging Markets Finance and Trade, 46(4), pp. 55-70.
• Özkan, F.G. (2000), “Who Wants an Independent Central Bank: Monetary Policymaking and Politics”, Scandinavian Journal of Economics, 102, pp. 621-643.
• Pereé, E. & Välilä, T. (2005), Fiscal Rules and Public Investment. Economic and Financial Report 2005/02, European Investment Bank.
• Romp, W. & De Haan, J. (2007), “Public Capital and Economic Growth: A Critical Survey”, Perspektiven der Wirtschaftspolitik, Special Issue, pp. 6-52.