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Abstract
This paper employs an endogenous growth model to study the growth and welfare effects of the golden rule of public finance. Two versions are compared, whereby government deficits are restricted for the use of public investments. It is shown that the growth effect of the golden rule depends on what kind of expenditure is adjusted to meet debt obligations. A transition from a balanced budget to a golden rule is performed to study welfare. The results indicate that a budget rule with detrimental growth effects can still have positive welfare implications, and vice versa, if the composition of government expenditures and transitional dynamics are taken into account.
Acknowledgements
Helpful comments from the editor are gratefully acknowledged. I also thank Wolfgang Kitterer and Alexander Ludwig for their assistance. A mathematical appendix is available from the author on request.
Notes
*with 1/σ>1,03 the transversality condition is violated.
1. See http://www.recovery.gov.
2. Congressional Budget Office (Citation2011, p. 15)
3. See Poterba (Citation1995) for an empirical investigation of US federal states.
4. For a discussion, see Mintz and Smart (Citation2006).
5. In a corrigendum, Minea and Villieu (Citation2010) also show negative growth effects of higher deficits analytically in the Greiner and Semmler setup.
6. In a companion paper (see Groneck Citation2010), I analyze growth and welfare effects of various budget rules. Here, I concentrate on the golden rule of public finance and the mechanism that determines the sign of the growth effect.
7. The government could, of course, also raise taxes to meet debt obligation. But this case will not be considered here.
8. For convenience the time index is omitted.
9. See, for example, Futagami et al. (Citation1993).
10. Version 1 thus corresponds to Regime (A) from Greiner and Semmler (Citation2000, p. 368).
11. A numerical proof of local stability for both versions of the golden rule is available in an appendix upon request.
12. This mechanism is studied by Minea and Villieu (Citation2009) in a fixed deficit rule with similar results.
13. This is done in a similar welfare analysis by Minea and Villieu (Citation2009) and Greiner (Citation2007a).
14. The value is close to what is chosen in the literature, see Turnovsky (Citation2004, p. 893). Generally, the range of empirical findings is extremely high, see Frederick et al. (Citation2002).
15. A description of the calculation of the consumption paths that are used to obtain the utility paths is relegated to the Appendix.
16. The reason to calculate equivalent variations instead of some relative net welfare measure is that relative welfare is sensitive to monotone transformations of the utility function.
17. The time horizon is chosen to be T=100 periods.
18. For expositional reasons, we restrict the following analysis to elasticities .
19. Formally: and
, where the index BB indicates the steady state with a balanced budget and GR indicates consumption with a golden rule (both versions).
20. See, for example, Greiner (Citation2007a) and Greiner (Citation2007b).
21. Their budget rule under study is comparable to Version 1 of this paper.
22. The parameters, taken from Minea and Villieu (Citation2009), are given by , and a deficit ratio
. They do not have public consumption expenditures, so we set
.
23. This result is in line with results from Atolia et al. (Citation2010, p. 1565, Figure 3).
24. These values are implausibly high, though. The fraction only accounts for public consumption expenditures, excluding interest payments and maintenance, which amount to around 40–50% for a long-run OECD average. The long-run OECD average for overall tax income relative to GDP is around 30–35%.
25. See Romp and De Haan (Citation2007) for a recent review.
26. For example, Baier and Glomm (Citation2001) use weight factors of private consumption between 0.925 and 0.85, Park and Philippopoulos (Citation2004) use a factor of 0.75.
