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American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Fiscal Rules, Bailouts, and Reputation in Federal Governments

  • Alessandro Dovis
  • Rishabh Kirpalani
American Economic Review
vol. 110, no. 3, March 2020
(pp. 860–88)
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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 to enforce penalties when rules are violated. 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.

Citation

Dovis, Alessandro, and Rishabh Kirpalani. 2020. "Fiscal Rules, Bailouts, and Reputation in Federal Governments." American Economic Review 110 (3): 860–88. DOI: 10.1257/aer.20181432

Additional Materials

JEL Classification

  • E62 Fiscal Policy
  • H62 National Deficit; Surplus
  • H63 National Debt; Debt Management; Sovereign Debt
  • H77 Intergovernmental Relations; Federalism; Secession
  • H81 Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts