Golden Rule (Economics) - Explained
What is the Golden Rule?
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Table of ContentsWhat is Golden Rule in Economics?Why is the Golden Rule Important for Fiscal Policy?Academic Research on the Golden Rule
What is Golden Rule in Economics?
In modern economics, the Golden Rule is an economic policy that says, a government must only borrow money for investing and not for funding the regular expense. That means a government should borrow money only to invest them for the benefit of the future generation and all the present expenses should be covered by tax revenue.
Why is the Golden Rule Important for Fiscal Policy?
The term Golden Rule was originally used in some ancient religious writings and the most popular version of it says, Do unto others as you would have them do unto you. In economic policy, the golden rule is not to burden the future generation with debt. According to the golden rule of fiscal policy, a government is only allowed to borrow money to invest it and not utilize it for the benefit of the current generation. The golden rule has been applied by many countries in their fiscal policy although the nature of application differs from one country to another. In most of the cases, the countries had to make some changes in their constitution in order to apply golden rule completely. However, in all the countries the basic is the government spends less than it earns. The countries that adopted the golden rule policy witnessed a significant reduction in their deficit after applying the rule. Switzerland is one of the countries that adopted the golden rule successfully in formulating their economic policy. As part of the policy, the Swiss government limited their spending to the projected revenue in the financial year. As a result, since 2004 the country has managed to keep its spending growth under 2% per year. The country has also increased its economic output faster than its spending. Germany has also adopted this rule and the countrys spending growth was reduced to below 0.2% from 2003 to 2007. It also enabled to create a budget surplus. New Zealand, Canada, and Sweden have applied this rule and experimented with it from time to time and managed to turn their deficit to surplus. The European Union applied its own version of the golden rule and mandated the nations with debts higher than 55% of GDP to reduce their structural deficit to less than 0.5% of GDP. In the United States, several attempts were made by different lawmakers to apply the golden rule, but none succeeded as the constitution of the United States does not require a balanced budget, nor does it impose any limits on spending. One of the most remarkable efforts to adopt the golden rule was made in 1985 by passing the Gramm-Rudmann-Hollings bill. The bill specified annual deficit targets and if the target is missed; an automatic sequestration process would start. The bill was later ruled out by the Supreme Court of the United States as unconstitutional and it was abandoned. In 1990, under the presidency of President Bill Clinton, the country witnessed budget surpluses due to certain temporary policies including a rise in tax and spending reduction.
Academic Research on the Golden Rule
- The golden rule of accumulation: a fable for growthmen, Phelps, E. (1961). The American Economic Review, 51(4), 638-643.This chapter analyzes the economic growth issue with special reference to the Solovian growth. It discusses the theorems proposed by a brilliant peasant named Oiko Nomos who claimed a prize for optimum investment ratio. Oiko suggested the golden-rule path is associated with a unique capital-output ratio. The chapter discusses the theorem and presents how the Solovian kingdom followed this golden rule of accumulation in their economy.
- Living by the golden rule: Multimarket contact in the US airline industry, Evans, W. N., & Kessides, I. N. (1994). The Quarterly Journal of Economics, 109(2), 341-366. The paper presents an empirical study analyzing the effects of multimarket contact on pricing in the airline industry of the United States. The study uses data from the 1000 largest domestic city-pair routes. Time-series and cross-sectional variability analysis were done. Presence of statistically significant and quantitatively important multimarket effects was evident in the results. The finding supports the claims that airlines follow the golden rule in their pricing.
- Models of technical progress and the golden rule of research, Phelps, E. S. (1966). The Review of Economic Studies, 33(2), 133-145. The paper attempts to present a model of technical progress and economic growth in order to derive a Golden Rule of Research which is quite similar to the Golden Rule of Accumulation. The paper also discusses the various models of technical progress.
- A catenary turnpike theorem involving consumption and the golden rule, Samuelson, P. A. (1965). The American Economic Review, 55(3), 486-496. In this paper, the author presents a brief sketch of a new kind of turnpike theorem that involves consumption and the golden rule.
- Free ride, free revelation, or golden rule?, Brubaker, E. R. (1975). The Journal of Law and Economics, 18(1), 147-161. The article discusses free revelation and golden rule as alternatives to the free-rider hypothesis. It argues the free-rider hypothesis which is dominant in the contemporary literature has a little empirical scientific basis. It asserts some other plausible alternatives are supported by the recently available experimental evidence as the evidence seems much more nearly consistent with those alternatives.
- Overcoming the golden rule: Sympathy and empathy, Bennett, M. J. (1979). Annals of the International Communication Association, 3(1), 407-422. "Treat others as you would like to be treated", the Golden Rule is essentially based on the assumption that everyone is similar and thus want to be treated similarly. This paper argues against this very notion of similarity and says one must accept that there are multiple realities and essential differences among people. While the golden rule leads us to a sympathetic communication, understanding others reality leads to an empathetic communication. In this strategy, one imaginatively experiences the reality from another persons perspective. The paper says this empathetic strategy of communication allows the interracial and intercultural sensitivity.
- Second essay on the golden rule of accumulation, Phelps, E. S. (1965). The American Economic Review, 55(4), 793-814. The paper examines the conditions needed for the existence of the Golden Rule path (consumption-maximizing golden age) and it shows that Golde Rule path may exist in both the un- neoclassical Harrod-Domar model and neoclassical model. It further shows that a positive-investment GR path can exist only if technical progress can be described as purely "labor-augmenting." In its second part, the paper discusses the normative properties of the Golde Rule path.
- Public investment, the stability pact and the 'Golden Rule', Balassone, F., & Franco, D. (2000). Fiscal studies, 21(2), 207-229. This paper focuses on two questions: the implication of the Stability and Growth Pact for public investment and the advantages and disadvantages of implementing a golden rule in EMUs fiscal framework. The analysis of the paper concludes that the rules set in the Treaty of Maastricht and Stability and Growth Pact may negatively public investment spending. It also suggests that the application of the golden rule is not an adequate solution to address the issue.
- The green golden rule, Chichilnisky, G., Heal, G., & Beltratti, A. (1995). Economics Letters, 49(2), 175-179. The paper introduces a growth model where the environmental asset is a source of utility and input to consumption and production. It attempts to develop the Green Golden Rule that is a generalization of the golden rule of neoclassical growth theory. The model is applied to a case where the objective is to maximize long -run or limiting utility and not long-run consumption.
- A golden rule over time: Reciprocity in intergenerational allocation decisions, Wade-Benzoni, K. A. (2002). Academy of Management Journal, 45(5), 1011-1028. This article presents a theoretical and empirical groundwork for studying intergenerational issues and focuses on the relevance of intergenerational behavior to organizations. It discusses different situations of conflict between two generations where the present generation must give up benefits or take up the burden for future generations. It introduces the concept of intergenerational reciprocity and the studies found that the behavior of previous generations influences the behavior of the present generation towards the future generation.
- Sustainable growth and the green golden rule, Beltratti, A., Chichilnisky, G., & Heal, G. (1993). National Bureau of Economic Research. The paper studies a growth model where an environmental asset is a source of utility and input to consumption and production. This study analyzes the implications of sustainable preference approach and defines Green Golden Rule. This Green Golden Rule is a path to maximize long-run sustainable utility from consumption and the environment.