Must-Read: Jonathan: Issues in the Design of Fiscal Policy Rules: “The potential conflict in designing rules between the need to mimic optimal policy…
…where debt is a shock absorber and is adjusted only very slowly, and the need to prevent deficit bias…. It may therefore make sense to make different recommendations depending on… the nature of governments…. [In] governments… not… subject to deficit bias… simple debt feedback rules come close to reproducing the optimal fiscal policy… [if] the exchange rate is floating and there is little risk of hitting the ZLB…. [G]overnment[s] behav[ing] in a non-benevolent manner… need… operational targets… fixed for the end of the natural term of the government… [to] provide strong incentives… for cyclically adjusted primary deficits…. These targets should be set in cooperation with a fiscal council, which would monitor progress… [and,] in exigent circumstances… suggest that the target be revised….
These rules should not apply if interest rates have hit the ZLB. In that case, fiscal policy should focus on demand stabilization… the suspension of the rule while the ZLB constraint applies, and not its modification. This ‘knockout’ should be an explicit part of the rule…