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A Visible Hand? Bond Markets, Political Parties, Balanced Budget Laws, and State Government Debt

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  • Robert C. Lowry

Abstract

Recent empirical work demonstrates that fiscal institutions in American states have real effects on state government bond rates, but the causal mechanisms have not been identified. We show how laws that restrict state governments' ability to carry forward a deficit improve the ability of investors to extract information from noisy signals. This affects the response of bond markets to repeated deficits in states that have these laws. We argue that partisan preferences for higher spending also increase risk for investors, leading to higher interest rates. We provide empirical support for our hypotheses using data from 1973-1995. Copyright Blackwell Publishers Ltd.

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  • Robert C. Lowry, 2001. "A Visible Hand? Bond Markets, Political Parties, Balanced Budget Laws, and State Government Debt," Economics and Politics, Wiley Blackwell, vol. 13(1), pages 49-72, March.
  • Handle: RePEc:bla:ecopol:v:13:y:2001:i:1:p:49-72
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    Citations

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    Cited by:

    1. Gebhard Kirchgassner, 2002. "The effects of fiscal institutions on public finance: a survey of the empirical evidence," Chapters,in: Political Economy and Public Finance, chapter 9 Edward Elgar Publishing.
    2. Heinemann, Friedrich & Osterloh, Steffen & Kalb, Alexander, 2014. "Sovereign risk premia: The link between fiscal rules and stability culture," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 110-127.
    3. repec:bla:pbudge:v:37:y:2017:i:4:p:47-73 is not listed on IDEAS
    4. Clemens, Jeffrey & Cutler, David M., 2014. "Who pays for public employee health costs?," Journal of Health Economics, Elsevier, vol. 38(C), pages 65-76.
    5. Feld, Lars P. & Kalb, Alexander & Moessinger, Marc-Daniel & Osterloh, Steffen, 2017. "Sovereign bond market reactions to no-bailout clauses and fiscal rules – The Swiss experience," Journal of International Money and Finance, Elsevier, vol. 70(C), pages 319-343.
    6. Lars P. Feld & Alexander Kalb & Marc-Daniel Moessinger & Steffen Osterloh, 2013. "Sovereign Bond Market Reactions to Fiscal Rules and No-Bailout Clauses - The Swiss Experience," CESifo Working Paper Series 4195, CESifo Group Munich.
    7. John A. Dove, 2016. "Do fiscal constraints prevent default? Historical evidence from U.S. municipalities," Economics of Governance, Springer, vol. 17(2), pages 185-209, May.
    8. António Afonso & João Jalles, 2017. "Do Fiscal Rules Lower Government Financing Costs?," Working Papers REM 2017/15, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    9. Cristina Arellano & Andrew Atkeson & Mark Wright, 2016. "External and Public Debt Crises," NBER Macroeconomics Annual, University of Chicago Press, vol. 30(1), pages 191-244.
    10. Kerstin Bernoth & Guntram B. Wolff, 2008. "Fool The Markets? Creative Accounting, Fiscal Transparency And Sovereign Risk Premia," Scottish Journal of Political Economy, Scottish Economic Society, vol. 55(4), pages 465-487, September.
    11. Andersen, Asger Lau & Lassen, David Dreyer & Nielsen, Lasse Holbøll Westh, 2014. "The impact of late budgets on state government borrowing costs," Journal of Public Economics, Elsevier, vol. 109(C), pages 27-35.
    12. Juan Carlos Hatchondo & Leonardo Martinez & Francisco Roch, 2012. "Fiscal rules and the sovereign default premium," Working Paper 12-01, Federal Reserve Bank of Richmond.
    13. repec:bla:pbudge:v:37:y:2017:i:3:p:24-46 is not listed on IDEAS
    14. Heiko T. Burret & Lars P. Feld, 2014. "A Note on Budget Rules and Fiscal Federalism," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(1), pages 03-11, 04.
    15. Clemens, Jeffrey, 2013. "State Fiscal Adjustment During Times of Stress: Possible Causes of the Severity and Composition of Budget Cuts," MPRA Paper 55921, University Library of Munich, Germany.
    16. repec:ces:ifodic:v:12:y:2014:i:1:p:19108838 is not listed on IDEAS

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