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American Economic Journal: Economic Policy: Vol. 2 No. 3 (August 2010)

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Dynamic Commitment and the Soft Budget Constraint: An Empirical Test

Article Citation

Pettersson-Lidbom, Per. 2010. "Dynamic Commitment and the Soft Budget Constraint: An Empirical Test." American Economic Journal: Economic Policy, 2(3): 154-79.

DOI: 10.1257/pol.2.3.154

Abstract

This paper develops an empirical framework for the problem of soft budgets which is explicitly based on a dynamic commitment problem, i.e., the inability of a supporting organization to commit itself not to extend more resources ex post to a budget-constrained organization than it was prepared to provide ex ante. Swedish local governments are used as a testing ground since the central government distributed a large number of fiscal transfers. The estimated soft-budget effect is economically significant: on average, a local government increases its debt by more than 20 percent by going from a hard to a soft budget constraint. (JEL D82, G32, L32)

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Authors

Pettersson-Lidbom, Per (Stockholm U)

JEL Classifications

D82: Asymmetric and Private Information
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
L32: Public Enterprises; Public-Private Enterprises

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