Output Stabilization Versus Deficit Sustainability: Is it a Trade-Off ?

Abstract

The adoption of tighter budget rules, including institutional restraints on the deficit that the government will be allowed to run, involves a cost by precluding automatic stabilization through the procyclical component of budget balance. This paper attempts to assess qualitatively the importance of this effect, by looking at the experience of main OECD countries over the last three decades. Our empirical approach is twofold. We first retain the cyclical sensitivity of the budget balance as a measure of automatic stabilizers and examine to which extent the strenght of this effect co-varies through time with a measure of sustainability. A second exercice considers the joint dynamics of GNP and budget balance, and attempts to evaluate the changes in GNP volatility involved by tighter budget adjustment rules. We generally find that the costs in terms of income stabilization of more sustainable budget rules are not important.