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Default, Reputation and Balanced-Budget Rules

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  • David R. Stockman

    (University of Delaware)

Abstract

Is a balanced-budget rule compatible with a government honoring its debt obligations? According to the conventional explanation, governments honor their debt obligations to maintain a good reputation for future borrowing. The ability of borrowing is desirable because it allows for greater tax smoothing. However, a balanced-budget rule limits the ability to smooth taxes, rendering a large class of competititve equilibria not compatible with a government honoring its debt obligations. The reputation model predicts default as the equilibrium outcome under a balanced-budget restriction. Insofar as this prediction is falsified by empirical observation, mechanisms other than reputation must be at work. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2003.09.002
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 7 (2004)
Issue (Month): 2 (April)
Pages: 382-405

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Handle: RePEc:red:issued:v:7:y:2004:i:2:p:382-405

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  1. Chari, V V & Kehoe, Patrick J, 1993. "Sustainable Plans and Mutual Default," Review of Economic Studies, Wiley Blackwell, vol. 60(1), pages 175-95, January.
  2. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  3. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
  4. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  6. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  7. Corsetti, Giancarlo & Roubini, Nouriel, 1992. "Tax Smoothing Discretion Versus Balanced Budget Rules in the Presence of Politically Motivated Fiscal Deficits: The Design of Optimal Fiscal Rules for Europe after 1992," CEPR Discussion Papers 682, C.E.P.R. Discussion Papers.
  8. Mankiw, N. Gregory, 1987. "The optimal collection of seigniorage : Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 327-341, September.
  9. Prescott, Edward C., 1977. "Should control theory be used for economic stabilization?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 7(1), pages 13-38, January.
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Cited by:
  1. Angyridis, Constantine, 2009. "Balanced budget vs. Tax smoothing in a small open economy: A welfare comparison," Journal of Macroeconomics, Elsevier, vol. 31(3), pages 438-463, September.
  2. Mario Coccia, 2012. "What are the effects of public debt on innovation and employment growth?," CERIS Working Paper 201206, Institute for Economic Research on Firms and Growth - Moncalieri (TO).

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