Working Paper: NBER ID: w23942
Authors: Alessandro Dovis; Rishabh Kirpalani
Abstract: Expectations of transfers by central governments incentivize overborrowing by local governments. In this paper, we ask if fiscal rules can reduce overborrowing if central governments cannot commit. We study a model in which the central government’s type is unknown and show that fiscal rules increase overborrowing if the central government’s reputation is low. In contrast, fiscal rules are effective in lowering debt if the central government’s reputation is high. Even when the central government’s reputation is low, binding fiscal rules will arise in the equilibrium of a signaling game.
Keywords: fiscal rules; bailouts; reputation; federal governments
JEL Codes: E40; E61; F5; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal rules (E62) | Increased debt accumulation among local governments (H74) |
| Central government's low reputation (H10) | Increased debt accumulation among local governments (H74) |
| Central government's high reputation (H11) | Lower borrowing (G51) |
| Fiscal rules (E62) | Lower borrowing (G51) |
| Central government's reputation (H11) | Local government borrowing decisions (H74) |
| Central government's low reputation (H10) | Fiscal indiscipline among local governments (H74) |
| Central government's high reputation (H11) | Compliance with fiscal rules (E62) |