Alternative Public Spending Rules and Output Volatility

One of the central lessons learned from the Great Depression was that adjusting government spending each year to balance the budget increases the volatility of output. We compare this policy with one that involves running temporary deficits and surpluses and an average budget balance of zero. Our analysis allows monetary policy to adjust to a change in fiscal regime, and the specifications for aggregate demand and supply are consistent with the "new neoclassical synthesis." Our results give only limited support to the conventional wisdom on fiscal rules and stability of output.