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Signaling Fiscal Regime Sustainability

  • Francesco Drudi

    (Banca d'Italia)

  • Alessandro Prati

    (IMF, Research Department)

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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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 335.

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Date of creation: Sep 1998
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Handle: RePEc:bdi:wptemi:td_335_98
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  3. Alessandro Prati & Francesco Drudi, 1999. "Signaling Fiscal Regime Sustainability," IMF Working Papers 99/86, International Monetary Fund.
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  8. Sutherland, Alan, 1997. "Fiscal crises and aggregate demand: can high public debt reverse the effects of fiscal policy?," Journal of Public Economics, Elsevier, vol. 65(2), pages 147-162, August.
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  11. Giavazzi, Francesco & Pagano, Marco, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," CEPR Discussion Papers 1284, C.E.P.R. Discussion Papers.
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  16. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  17. Vickers, John, 1986. "Signalling in a Model of Monetary Policy with Incomplete Information," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 443-55, November.
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  19. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
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  22. Drudi, Francesco & Prati, Alessandro, 1993. "Signalling Debt Sustainability," CEPR Discussion Papers 787, C.E.P.R. Discussion Papers.
  23. Fernandez, Raquel & Rodrik, Dani, 1991. "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty," American Economic Review, American Economic Association, vol. 81(5), pages 1146-55, December.
  24. Alberto Alesina & Roberto Perotti, 1995. "Fiscal Expansions and Fiscal Adjustments in OECD Countries," NBER Working Papers 5214, National Bureau of Economic Research, Inc.
  25. V. V. Chari & Patrick J. Kehoe, 1993. "Sustainable Plans and Mutual Default," Review of Economic Studies, Oxford University Press, vol. 60(1), pages 175-195.
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  27. Luigi Spaventa, 1987. "The Growth of Public Debt: Sustainability, Fiscal Rules, and Monetary Rules," IMF Staff Papers, Palgrave Macmillan, vol. 34(2), pages 374-399, June.
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