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 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 sucessfully test it on Irish , Belgian, and Danish data from the late 1970s to the early 1990s.
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Paper provided by Banca Italia - Servizio di Studi in its series Papers with number
335.
Find related papers by JEL classification: E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy H2 - Public Economics - - Taxation, Subsidies, and Revenue
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