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Dynamic Commitment and the Soft Budget Constraint: An Empirical Test

  • Per Pettersson-Lidbom

This paper develops an empirical framework for the problem of soft budgets which is explicitly based on a dynamic commitment problem, i.e., the inability of a supporting organization to commit itself not to extend more resources ex post to a budget-constrained organization than it was prepared to provide ex ante. Swedish local governments are used as a testing ground since the central government distributed a large number of fiscal transfers. The estimated soft-budget effect is economically significant: on average, a local government increases its debt by more than 20 percent by going from a hard to a soft budget constraint. (JEL D82, G32, L32)

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Article provided by American Economic Association in its journal American Economic Journal: Economic Policy.

Volume (Year): 2 (2010)
Issue (Month): 3 (August)
Pages: 154-79

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Handle: RePEc:aea:aejpol:v:2:y:2010:i:3:p:154-79
Note: DOI: 10.1257/pol.2.3.154
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