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Default, Reputation and Balanced-Budget Rules

  • David R. Stockman

    (University of Delaware)

Is a balanced-budget rule compatible with a government honoring its debt obligations? According to the conventional explanation, governments honor their debt obligations to maintain a good reputation for future borrowing. The ability of borrowing is desirable because it allows for greater tax smoothing. However, a balanced-budget rule limits the ability to smooth taxes, rendering a large class of competititve equilibria not compatible with a government honoring its debt obligations. The reputation model predicts default as the equilibrium outcome under a balanced-budget restriction. Insofar as this prediction is falsified by empirical observation, mechanisms other than reputation must be at work. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2003.09.002
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 7 (2004)
Issue (Month): 2 (April)
Pages: 382-405

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Handle: RePEc:red:issued:v:7:y:2004:i:2:p:382-405
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  1. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  2. Corsetti, Giancarlo & Roubini, Nouriel, 1992. "Tax Smoothing Discretion Versus Balanced Budget Rules in the Presence of Politically Motivated Fiscal Deficits: The Design of Optimal Fiscal Rules for Europe after 1992," CEPR Discussion Papers 682, C.E.P.R. Discussion Papers.
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