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Soft budget constraints and strategic interactions in subnational borrowing: Evidence from the German States, 1975–2005

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  • Baskaran, Thushyanthan

Abstract

Cooperative federations are usually characterized by the existence of bailout guarantees and intergovernmental transfer schemes. This paper explores whether such features of cooperative federations lead to subnational soft budget constraints using panel data from the German States covering the 1975–2005 period. The methodology is based on the premise that subnational governments’ borrowing will exhibit vertical and horizontal strategic interactions if they operate under soft budget constraints. Therefore, a test for strategic interactions in subnational borrowing can be used to infer whether a cooperative federation like Germany is susceptible to soft budget constraints. The results suggest that state borrowing in Germany exhibited horizontal but not vertical interactions during the time-frame of the analysis. This indicates (i) that German States faced soft budget constraints and (ii) that they were more concerned about the likelihood of a bailout than about its volume.

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  • Baskaran, Thushyanthan, 2012. "Soft budget constraints and strategic interactions in subnational borrowing: Evidence from the German States, 1975–2005," Journal of Urban Economics, Elsevier, vol. 71(1), pages 114-127.
  • Handle: RePEc:eee:juecon:v:71:y:2012:i:1:p:114-127
    DOI: 10.1016/j.jue.2011.07.003
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    Keywords

    Fiscal federalism; Soft budget constraints; Strategic fiscal interactions;

    JEL classification:

    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism

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