Balanced Budget Rule and Economic Growth

This paper studies the impact of a Balanced Budget rule (BBR) over the business cycle on economic growth, as adopted in Switzerland’s constitution in 2003. Its distinctive feature is that the government deficit limit is flexible depending on the comparison between real and potential GDP, unlike the fixed 3% limit in the European Union. First, using a synthetic control method, I document that from 2003 to 2018, the BBR adoption has been associated with an average annual growth rate of 0.95% in Switzerland. Second, I document that the increase in growth is due to the increase in Total Factor Productivity (TFP), which includes institutional changes such as the adoption of the BBR. Third, I build an endogenous growth model with a shortsighted government making inefficient decisions. I find that by reducing public debt, the BBR tempers the "crowding-out effect of debt" and frees up resources for private investment in R&D. Additionally, by reducing the service of the debt, it frees up resources for public investment in R&D. These investments, in turn, foster economic growth through their effect on TFP. The model calibrated to Switzerland shows that the long-term yearly growth effect of the BBR is 1.27 basis points, which compounds to a 3% GDP gain after 30 years.

Click here for the Paper: https://fansakone.github.io/files/BBR_and_growth__paper_.pdf