The Value of Constraints on Discretionary Government Policy

Recent events have renewed the debate on the desirability of imposing institutional constraints on government policy. This paper investigates how policy constraints discipline the behavior of discretionary governments in dynamic stochastic monetary economies and evaluates the welfare properties of such restrictions. Across a variety of possible shocks, the best policy is to impose a minimum surplus at all times, of about half a percent of output. Most welfare gains derived from imposing policy constraints arise from the imposed discipline on government behavior during normal times. It is not optimal to ever suspend constraints on fiscal policy, whereas monetary policy constraints should only be imposed during normal times. ∗Email: [email protected]. I would like to thank my colleagues at the St. Louis Fed for valuable comments to an earlier version of this draft. The views expressed in this paper do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors.