An Empirical Investigation of the Strategic Use of Debt
In this paper I test whether there are strategic considerations in the making of fiscal policy. The general idea is that if a government anticipates the possibility of defeat in the next election it will try to use the debt strategically in order to influence the policy of its successor. Previous empirical studies have either rejected the strategic explanation of debt or have not been able to isolate this effect. I argue that these findings might be due to potential difficulties with the data sets used. To come to grips with these problems I make use of a data set from Swedish local governments. The main advantages of this panel data set are the institutional and constitutional homogeneity of the sample and the large number of observations from elections, nearly 2000. The main findings of this paper strongly suggest that there are strategic considerations in the making of fiscal policy. A right-wing government accumulates more debt during its term of office if it thinks that it will be defeated as compared to when it expects to remain in office. On the other hand, a left-wing government decreases the level of debt the higher the possibility of its defeat. Moreover, the larger the inherited debt the more a newly elected government has to reduce spending. These results are consistent with the predictions from a model developed by Persson and Svensson (1989).
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