The welfare and stabilization benefits of fiscal rules

Given the greater simplicity of a rule based on the moving average of past revenue, and the need for policymakers to communicate the form and method of operation of a fiscal rule to the public, our findings suggest that a simpler rule may be preferred. [...] Calculation of the welfare benefits We calculate the welfare of the fiscal rule relative to the welfare of the baseline, where the baseline is a balanced budget policy of spending all revenue as it is received. [...] More formally, the welfare gain from the fiscal rule is the value of τ that makes expected utility under the baseline equal to expected utility under the fiscal rule, so τ, measured as a percent of government expenditure, is the solution to: 7 We assume that the parameters in the equations for output and government revenue in the VAR do not depend on the fiscal rule. [...] The processes determining the paths for these variables are derived using a three variable VAR of the log of output, y, the log of government revenue, r, and the log of government program expenditure, g, with the expenditure equation replaced by the fiscal rule. [...] We repeat this procedure for the resource provinces, since the standard deviations of the shocks differ for this subsample.12 To make the calculation of the welfare gains tractable, output and government revenue and expenditure are assumed to be stochastic for only 200 periods, with the fiscal rule imposed and the simulation run on the final 100 of these observations.