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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 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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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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  19. Drudi, Francesco & Prati, Alessandro, 1993. "Signalling Debt Sustainability," CEPR Discussion Papers 787, C.E.P.R. Discussion Papers.
  20. Tabellini, Guido & Alesina, Alberto, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Scholarly Articles 3612769, Harvard University Department of Economics.
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  23. Cole, Harold L & Dow, James & English, William B, 1995. "Default, Settlement, and Signalling: Lending Resumption in a Reputational Model of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 365-85, May.
  24. Alesina, A. & Drazen, A., 1991. "Why Are Stabilizations Delayed?," Papers 6-91, Tel Aviv - the Sackler Institute of Economic Studies.
  25. Francesco Giavazzi & Marco Pagano, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," NBER Working Papers 5332, National Bureau of Economic Research, Inc.
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