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A Theory of Fiscal Responsibility and Irresponsibility

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  • Halac, Marina
  • Yared, Pierre

Abstract

We propose a political economy mechanism that explains the presence of fiscal regimes punctuated by crisis periods. Our model focuses on the interaction between successive deficit-biased governments subject to i.i.d. fiscal shocks. We show that the economy transitions between a fiscally responsible regime and a fiscally irresponsible regime, with transitions occurring during crises when fiscal needs are large. Under fiscal responsibility, governments limit their spending to avoid transitioning to fiscal irresponsibility. Under fiscal irresponsibility, governments spend excessively and precipitate crises that lead to the reinstatement of fiscal responsibility. Regime transitions can only occur if governments' deficit bias is large enough.

Suggested Citation

  • Halac, Marina & Yared, Pierre, 2022. "A Theory of Fiscal Responsibility and Irresponsibility," CEPR Discussion Papers 17626, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17626
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    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H1 - Public Economics - - Structure and Scope of Government
    • P16 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Capitalist Institutions; Welfare State

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