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Signaling fiscal regime sustainability

  • Drudi, Francesco
  • Prati, Alessandro

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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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 44 (2000)
Issue (Month): 10 (December)
Pages: 1897-1930

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Handle: RePEc:eee:eecrev:v:44:y:2000:i:10:p:1897-1930
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