The standard analysis of the efficient management of income taxes and debt assumes a benevolent government and ignores potential distortions arising from rent-seeking politicians. This paper departs from this framework by assuming that a rent-seeking politician chooses policies. If the politician chooses extractive policies, citizens throw him out of power. We analyse the efficient sustainable equilibrium. Unlike in the standard economy, temporary economic shocks generate volatile and persistent changes in taxes along the equilibrium path. This serves to optimally limit rent-seeking by the politician and to optimally generate support for the politician from the citizens. Taxes resembling those of the benevolent government are very costly since the government over-saves and resources are wasted on rents. Political distortions thus cause the complete debt market to behave as if it were incomplete. However, in contrast to an incomplete market economy, in the long run, taxes do not converge to zero, and under some conditions, they resemble taxes under a benevolent government.

We study rules based on instruments versus targets. Our application is a New Keynesian economy where the central bank has non-contractible information about aggregate demand shocks and cannot commit to policy. Incentives are provided to the central bank via punishment which is socially costly. Instrument-based rules condition incentives on the central bank’s observable choice of policy, whereas target-based rules condition incentives on the outcomes of policy, such as inflation, which depend on both the policy choice and realized shocks. We show that the optimal rule within each class takes a threshold form, imposing the worst punishment upon violation. Target-based rules dominate instrument-based rules if and only if the central bank’s information is sufficiently precise, and they are relatively more attractive the less severe the central bank’s commitment problem. The optimal unconstrained rule relaxes the instrument threshold whenever the target threshold is satisfied.

This paper studies the optimal level of discretion in policymaking. We consider a fiscal policy model where the government has time-inconsistent preferences with a present bias toward public spending. The government chooses a fiscal rule to trade off its desire to commit to not overspend against its desire to have flexibility to react to privately observed shocks to the value of spending. We analyze the optimal fiscal rule when the shocks are persistent. Unlike under independent and identically distributed shocks, we show that the ex ante optimal rule is not sequentially optimal, as it provides dynamic incentives. The ex ante optimal rule exhibits history dependence, with high shocks leading to an erosion of future fiscal discipline compared to low shocks, which lead to the reinstatement of discipline. The implied policy distortions oscillate over time given a sequence of high shocks, and can force the government to accumulate maximal debt and become immiserated in the long run.

Governments are present-biased toward spending. Fiscal rules are deficit limits that trade off commitment to not overspend and flexibility to react to shocks. We compare coordinated rules, chosen jointly by a group of countries, to uncoordinated rules. If governments’ present bias is small, coordinated rules are tighter than uncoordinated rules: individual countries do not internalize the redistributive effect of interest rates. However, if the bias is large, coordinated rules are slacker: countries do not internalize the disciplining effect of interest rates. Surplus limits enhance welfare, and increased savings by some countries or outside economies can hurt the rest. (JEL D82, E43, E62, H62)

We propose a political economy mechanism that explains the presence of fiscal regimes punctuated by crisis periods. Our model focuses on the interaction between successive deficit-biased governments subject to independently and identically distributed fiscal shocks. We show that the economy transitions between a fiscally responsible regime and a fiscally irresponsible regime, with transitions occurring during crises when fiscal needs are large. Under fiscal responsibility, governments limit their spending to avoid transitioning to fiscal irresponsibility. Under fiscal irresponsibility, governments spend excessively and precipitate crises that lead to the reinstatement of fiscal responsibility. Regime transitions can occur only if governments’ deficit bias is large enough.

A principal faces an agent who is better informed but biased toward higher actions. She can verify the agent’s information and specify his permissible actions. We show that if the verification cost is small enough, a threshold with an escape clause (TEC) is optimal: the agent either chooses an action below a threshold or requests verification and the efficient action above the threshold. For higher costs, however, the principal may require verification only for intermediate actions, dividing the delegation set. TEC is always optimal if the principal cannot commit to inefficient allocations following the verification decision and result.

This article studies the causes of China's Great Famine, during which 16.5 to 45 million individuals perished in rural areas. We document that average rural food retention during the famine was too high to generate a severe famine without rural inequality in food availability; that there was significant variance in famine mortality rates across rural regions; and that rural mortality rates were positively correlated with per capita food production, a surprising pattern that is unique to the famine years. We provide evidence that an inflexible and progressive government procurement policy (where procurement could not adjust to contemporaneous production and larger shares of expected production were procured from more productive regions) was necessary for generating this pattern and that this policy was a quantitatively important contributor to overall famine mortality.

According to the Lucas-Stokey result, a government can structure its debt maturity to guarantee commitment to optimal fiscal policy by future governments. In this paper, we overturn this conclusion, showing that it does not generally hold in the same model and under the same definition of time consistency as in Lucas-Stokey. Our argument rests on the existence of an overlooked commitment problem that cannot be remedied with debt maturity: a government in the future will not necessarily tax above the peak of the Laffer curve, even if it is ex ante optimal to do so.

The conventional wisdom views high levels of education as a prerequisite for democracy. This paper shows that existing evidence for this view is based on crosssectional correlations, which disappear once we look at within-country variation. In other words, there is no evidence that countries that increase their education are more likely to become democratic.