Fiscal Rules and Sustainability of Public Finances in an Endogenous Growth Model

This paper presents a two period overlapping generations model with en- dogenous growth in the presence of a public sector with objectives of conver- gence for public debt and primary balance to GDP ratios. In order to ensure the existence of converging paths towards the target values of ¯scal variables, we introduce a simple ¯scal policy rule. According to this rule, the primary balance ratio is adjusted in function of the distance between the current and the target levels of the public debt and the primary surplus to GDP ratios. It is shown that the ¯scal rule displaying time invariant parameters may pro- duce non linear dynamic processes of adjustment of the ¯scal ratios as well as endogenous °uctuations in the rate of growth of the economy. In addi- tion the transitional process towards ¯scal targets critically depends on the adjustment tool chosen by the ¯scal authorities to implement the rule