Fiscal counter-cyclical rules and their conflicting implications for growth and welfare

The paper examines the choices for fiscal stabilisation policy that maximise aggregate welfare and long-run growth. This is done in the context of a stochastic dynamic general equilibrium model where premeditated learning provides the engine of human capital accumulation and growth, and technology shocks provide the impulse source of fluctuations. Contrary to existing conventional wisdom, the results indicate a conflict between the two policy objectives: the choice of no stabilisation, associated with maximum growth, is also associated with minimum welfare. Welfare maximisation requires a full counter-cyclical response to the occurrence of business cycles. I am grateful to three anonymous referees for their constructive comments and suggestions. I would also like to thank Theodore Palivos, Keith Blackburn, seminar participants in Athens and Thessaloniki, and participants at the 2006 conference on Theories and Methods in Macroeconomics (Toulouse) and the 2007 conference of the Society for the Advancement of Economic Theory (Kos), for their valuables comments and suggestions on earlier drafts. Any errors and omissions are mine.