Fiscal Rules, Bailouts, and Reputation in Federal Governments

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. (JEL E62, H62, H63, H77, H81)

Fiscal Rules Cause Lower Debt: Evidence from Switzerland’s Federal Debt Containment Rule

“…However, some countries in the Euro Area were able to violate the stability targets with limited consequences. To mitigate the risk that countries abandon formal sanctions, some studies discuss the use of formal enforcement and enhancing the reputational costs of breaching rules (Dovis and Kirpalani 2018; Halac and Yared 2019). For instance, the presence of a fiscal councils has been associated with more accurate and possibly less optimistic fiscal forecasts, as well as greater compliance with fiscal rules (e.g., Beetsma and Debrun 2018).…”

El diseño de reglas fiscales en Gobiernos subcentrales. El caso de España

“…Otro vector de discusión acerca del éxito relativo de la actual gobernanza fiscal exige tratar los importantes problemas relacionados con la reforma de los sistemas de financiación autonómica y local (Instituto de Estudios Fiscales, 2018 horizontales -especialmente en el ámbito autonómico-que pueden condicionar sin duda los esfuerzos de consolidación fiscal o al menos la legitimidad para exigirlos (Dovis y Kirpalani, 2020;Martínez López, 2020a).…”

Fiscal Stimulus Under Sovereign Risk

“…Fiscal rules have also been shown to counteract political economy distortions(Alesina and Tabellini, 1990;Azzimonti, Battaglini and Coate, 2016;Alfaro and Kanczuk, 2017) Halac and Yared (2017). andDovis and Kirpalani (2017) study reputation mechanisms under which the government cannot commit to enforcing fiscal rules.…”