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Binding Constraints and Second-Best Strategies in Endogenous Growth Models with Public Finance

Florian Misch, Norman Gemmell () and Richard Kneller ()

Journal of Globalization and Development, 2010, vol. 1, issue 2, 1-37

Abstract: This paper uses an endogenous growth model with public finance to test whether alleviating the most binding constraint to growth corresponds to the optimal fiscal policy adjustment. It makes two contributions: first, it shows that this strategy is optimal if there is only one policy adjustment which alleviates the most binding constraint. When there are several, some of them may in fact reduce growth. The second contribution is therefore to develop a simple guiding principle for this situation: we show that it is likely optimal to adopt the policy adjustment which alleviates the most and worsens the least binding constraint.

Date: 2010
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DOI: 10.2202/1948-1837.1068

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