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Public Financing Under Balanced Budget Rules

Author

Listed:
  • Minjie Deng

    (Simon Fraser University)

  • Chang Liu

    (National University of Singapore)

Abstract

This paper analyzes the impact of a balanced budget rule (BBR) on government financing costs and its implications for the government balance sheet. Exploiting the variation in BBR implementation across US states, we find that states with more stringent BBRs exhibit significantly lower bond spreads and credit default swap spreads, demonstrating the crucial role of default risk. A sovereign default model, which features long-term debt, endogenous investment and output, as well as a BBR, aligns with the empirical result. Calibrated to Illinois, our quantitative analysis suggests that implementing a BBR could dramatically decrease the state bond spread, gradually lower the debt, and improve welfare in the long run. (Copyright: Elsevier)

Suggested Citation

  • Minjie Deng & Chang Liu, 2025. "Public Financing Under Balanced Budget Rules," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 56, April.
    • Handle: RePEc:red:issued:23-24
    DOI: 10.1016/j.red.2025.101275
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    References listed on IDEAS

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    More about this item

    Keywords

    Public financing; balanced budget rule; sovereign default risk; state government; fiscal rule;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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