Debt Ceiling Rules under Intermediate Commitment: Discussion Paper

Fiscal rules can help countries with long-term debt overcome time-inconsistent default incentives, but enforcement is often imperfect. We integrate an optimal fiscal policy framework under partial commitment with a sovereign default model featuring long-term debt, introducing an endogenously announced debt ceiling as a fiscal rule. First, we analyze a baseline environment where governments announce a ceiling each period and incur a proportional cost for issuing above it. Second, we extend the model to a political economy setting with heterogeneous agents, where competing parties renegotiate the inherited ceiling, thereby microfounding the cost. The ceiling reduces debt dilution but limits fiscal flexibility. Calibrated to Argentina, our counterfactual shows that welfare gains from such a rule are possible but not guaranteed, a finding that persists in the fully microfounded model.