To understand the effect of fiscal policy on the private sector we have to comprehend how expectations about fiscal variables are formed. However, little is known about the way people form expectations about fiscal variables: no undercutting theory exists, not to say empirical evidence. The problem is that “expectations are unobservable” (Bertola and Drazen [BD93, p.16]). We generate observable...

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This paper studies the interactions of fiscal and monetary policies in the presence of fiscal spillovers within a monetary union. When capital markets are integrated, the fiscal policy of any member country will influence equilibrium wages and interest rates across the whole union. Thus there are fiscal spillovers within a federation. Within a general class of monetary policy rules, there does ...

Fiscal policy restrictions are often criticized for limiting the ability of governments to react to business cycle fluctuations. Therefore, the adoption of quantitative restrictions is viewed as inevitably leading to increased macroeconomic volatility. In this paper we use data from 48 U.S. states to investigate how budget rules affect fiscal policy outcomes. Our key findings are that (1) stric...

This paper studies the validity of the Modigliani and Miller Irrelevance proposition in the presence of incomplete markets and portfolio restrictions. If the economy is originally in equilibrium and the firm changes its financial plan, we show that there exist state-dependent trading limits under which financial policy is always irrelevant. In addition, the no short-selling constraint usually i...

It is a great pleasure for me to discuss the essay by Karl Brunner; this continues a tradition of discussing each other’s work that dates back at least a decade. Much of Brunner’s massive survey is admirable, reflecting a deep and careful analysis of central issues in fiscal policy, and the way events have changed perceptions of fiscal policy. The comprehensive and up-to-date reference list add...

This paper investigates the effects of fiscal policy on the trade balance using a structural factor model. A fiscal policy shock worsens the trade balance and produces an appreciation of the domestic currency but the effects are quantitatively small. The findings match the theoretical predictions of the standard Mundell-Fleming model, although fiscal policy should not be considered one of the m...

The current buildup of the U.S. Social Security Trust Fund has caused speculation about both the potential consequences of the buildup under different policy objectives and the fund's management. As is often the case, the search for precedents under similar circumstances abroad has been quite extensive on the part of legislators and U.S. experts in the field of financial policy. This article su...

The ability of voters to monitor government officials is complicated by the large changes in government spending caused by the business cycle. Voters may be uncertain about the cumulative effect of changes in spending that occur over several years, and thus budget allocations may be different from voters’ ideal. For the years 1989 through 2006, we examine states’ responses to revenue shocks, wh...