Optimal fiscal rules balance debt limits and default risks for governments.
Governments often accumulate too much debt, leading to the need for fiscal rules. A study looked at the best rules for governments that can default on their debt. They found that the optimal rules depend on the possibility of default and the government's spending habits. In some cases, strict debt limits are needed, while in others, default rules are necessary. The severity of spending bias and the cost of default determine the best approach.