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Signaling Fiscal Regime Sustainability

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Author Info

  • Francesco Drudi

    (Banca d'Italia)

  • Alessandro Prati

    (IMF, Research Department)

Abstract

This paper proposes a signaling model of fiscal stabilizations that offers a new perspective on why governments deviate from optimal tax smoothing. In our model, dependable - but not fully credible - governments have an incentive to tighten the fiscal regime when the signaling effect on credit ratings is larger (that is, when a sufficiently large stock of debt has been accumulated). At this point, they may deviate from tax smoothing in order to avoid being mimicked by weak governments. We show that a testable prediction of our model is that primary balances and debt stocks are complementary inputs in the credit rating function and we successfully test it on Irish, Belgian, and Danish data from the late 1970s to the early 1990s.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 335.

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Date of creation: Sep 1998
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Handle: RePEc:bdi:wptemi:td_335_98

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Web page: http://www.bancaditalia.it
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Related research

Keywords: fiscal policy; taxation; debt; credit; economic models;

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References

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  1. Bertola, Giuseppe & Drazen, Allan, 1993. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," American Economic Review, American Economic Association, vol. 83(1), pages 11-26, March.
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  3. Atkeson, Andrew, 1991. "International Lending with Moral Hazard and Risk of Repudiation," Econometrica, Econometric Society, vol. 59(4), pages 1069-89, July.
  4. Giavazzi, Francesco & Pagano, Marco, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," CEPR Discussion Papers 1284, C.E.P.R. Discussion Papers.
  5. Alan Sutherland, . "Fiscal Crises and Aggregate Demand: Can High Public Debt Reverse the Effects of Fiscal Policy?," Discussion Papers 95/17, Department of Economics, University of York.
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  8. Alessandro Missale & Francesco Giavazzi & Pierpaolo Benigno, . "Managing the Public Debt in Fiscal Stabilizations: the Evidence," Working Papers 118, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  9. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  10. V.V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans," Staff Report 122, Federal Reserve Bank of Minneapolis.
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  12. Cukierman, Alex & Liviatan, Nissan, 1991. "Optimal accommodation by strong policymakers under incomplete information," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 99-127, February.
  13. Alberto Alesina & Roberto Perotti, 1995. "Fiscal Expansions and Fiscal Adjustments in OECD Countries," NBER Working Papers 5214, National Bureau of Economic Research, Inc.
  14. Harold L. Cole & James Dow & William B. English, 1994. "Default, settlement, and signalling: lending resumption in a reputational model of sovereign debt," Staff Report 180, Federal Reserve Bank of Minneapolis.
  15. Francesco Drudi & Alessandro Prati, 1998. "Signaling Fiscal Regime Sustainability," Temi di discussione (Economic working papers) 335, Bank of Italy, Economic Research and International Relations Area.
  16. Alberto Alesina & Roberto Perotti, 1995. "The Political Economy of Budget Deficits," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 1-31, March.
  17. Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 75-122 National Bureau of Economic Research, Inc.
  18. Alesina, Alberto & Drazen, Allan, 1991. "Why Are Stabilizations Delayed?," American Economic Review, American Economic Association, vol. 81(5), pages 1170-88, December.
  19. Alberto Alesina & Roberto Perotti, 1997. "Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects," IMF Staff Papers, Palgrave Macmillan, vol. 44(2), pages 210-248, June.
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  23. repec:fth:coluec:754 is not listed on IDEAS
  24. Herschel I. Grossman & John B. Van Huyck, 1985. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," NBER Working Papers 1673, National Bureau of Economic Research, Inc.
  25. Luigi Spaventa, 1987. "The Growth of Public Debt: Sustainability, Fiscal Rules, and Monetary Rules," IMF Staff Papers, Palgrave Macmillan, vol. 34(2), pages 374-399, June.
  26. Vickers, John, 1986. "Signalling in a Model of Monetary Policy with Incomplete Information," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 443-55, November.
  27. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
  28. Drudi, Francesco & Prati, Alessandro, 1993. "Signalling Debt Sustainability," CEPR Discussion Papers 787, C.E.P.R. Discussion Papers.
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Citations

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Cited by:
  1. Castriota, Stefano & Delmastro, Marco, 2008. "Individual and Collective Reputation: Lessons from the Wine Market," Working Papers 45504, American Association of Wine Economists.
  2. Siviero, S. & Terlizzese, D. & Visco, I., 1999. "Are Model-Based Inflation Forecasts Used in Monetary Policymaking? A Case Study," Papers 357, Banca Italia - Servizio di Studi.
  3. Drudi, Francesco & Giordano, Raffaela, 2000. "Default risk and optimal debt management," Journal of Banking & Finance, Elsevier, vol. 24(6), pages 861-891, June.
  4. Alessandro Prati & Francesco Drudi, 1999. "Signaling Fiscal Regime Sustainability," IMF Working Papers 99/86, International Monetary Fund.
  5. Ardagna, Silvia & Caselli, Francesco & Lane, Timothy, 2004. "Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries," CEPR Discussion Papers 4661, C.E.P.R. Discussion Papers.
  6. Fiess, Norbert, 2003. "Capital flows, country risk, and contagion," Policy Research Working Paper Series 2943, The World Bank.
  7. Benigno, Pierpaolo & Missale, Alessandro, 2004. "High public debt in currency crises: fundamentals versus signaling effects," Journal of International Money and Finance, Elsevier, vol. 23(2), pages 165-188, March.
  8. World Bank, 2004. "Grenada, OECS Fiscal Issues : Policies to Achieve Fiscal Sustainability and Improve Efficiency and Equity of Public Expenditures," World Bank Other Operational Studies 13939, The World Bank.
  9. Marchesi, S., 2000. "Buybacks of Domestic Debt in Public Debt Management," The Warwick Economics Research Paper Series (TWERPS) 573, University of Warwick, Department of Economics.
  10. Samir Jahjah, 2001. "Financial Stability and Fiscal Crises in a Monetary Union," IMF Working Papers 01/201, International Monetary Fund.

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