A principal allocates a budget to an agent in each of two periods. The agent chooses an effort level to efficiently use the budget in period 1, anticipating the principal’s decision in period 2. The agent can gain a larger budget in period 2 by exerting less effort in period 1. Fiscal caps imposed in both periods can induce the agent to devote the socially optimal level of effort, but the fiscal cap for the final period may be too generous, providing for discretionary expenditure that is contingent upon the state of the overall economy. Whether fiscal constraints are desirable depends on the rigidity applied in the primary budget.
