IDEAS home Printed from https://ideas.repec.org/p/hhs/uunewp/2003_028.html
   My bibliography  Save this paper

An Empirical Approach for Evaluating Soft Budget Constraints

Author

Listed:
  • Pettersson-Lidbom, Per

    () (Stockholm university)

  • Dahlberg, Matz

    () (Department of Economics)

Abstract

In this paper, we develop an empirical framework for detecting the existence and estimating the magnitude of the softness of a budget constraint. The defining feature of a soft budget constraint is a subordinate organization’s expectations of being bailed out by a superior organization in case of financial trouble. This implies that one has to link the organization’s expectations for being bailed out to its fiscal behavior in order to quantify the extent of the soft budget constraint. We postulate that expectations for bailouts are formed rationally and make use of an instrumental variable method to get consistent estimates of the parameters of interest. We argue that past own experience of being bailed out and bailouts of other subordinate organizations can be used to construct credible instruments for the formation of bailout expectations. We apply our empirical approach to a unique panel data set of 286 Swedish local governments where the central government provided a total of 1,697 bailouts between 1974 and 1992. Our results strongly suggest the existence of a soft budget constraint; a local government increases its level of debt by 6-10 percent if it expects to be bailed out with probability one as compared to when the likelihood is zero due to previous experience of being bailed out, while the effect on debt from bailouts of its geographical neighbors is roughly four times as large.

Suggested Citation

  • Pettersson-Lidbom, Per & Dahlberg, Matz, 2003. "An Empirical Approach for Evaluating Soft Budget Constraints," Working Paper Series 2003:28, Uppsala University, Department of Economics.
  • Handle: RePEc:hhs:uunewp:2003_028
    as

    Download full text from publisher

    File URL: http://www.nek.uu.se/pdf/wp2003_28.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Besley, Timothy & Case, Anne, 1995. "Incumbent Behavior: Vote-Seeking, Tax-Setting, and Yardstick Competition," American Economic Review, American Economic Association, vol. 85(1), pages 25-45, March.
    2. Brock, William A. & Durlauf, Steven N., 2001. "Interactions-based models," Handbook of Econometrics,in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 5, chapter 54, pages 3297-3380 Elsevier.
    3. Qian, Yingyi & Roland, Gerard, 1998. "Federalism and the Soft Budget Constraint," American Economic Review, American Economic Association, vol. 88(5), pages 1143-1162, December.
    4. M. R. Wickens, 1982. "The Efficient Estimation of Econometric Models with Rational Expectations," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 55-67.
    5. McCallum, Bennett T, 1976. "Rational Expectations and the Natural Rate Hypothesis: Some Consistent Estimates," Econometrica, Econometric Society, vol. 44(1), pages 43-52, January.
    6. M. Dewatripont & E. Maskin, 1995. "Credit and Efficiency in Centralized and Decentralized Economies," Review of Economic Studies, Oxford University Press, vol. 62(4), pages 541-555.
    7. Wallis, Kenneth F, 1980. "Econometric Implications of the Rational Expectations Hypothesis," Econometrica, Econometric Society, vol. 48(1), pages 49-73, January.
    8. Anderson, James H. & Korsun, Georges & Murrell, Peter, 2000. "Which Enterprises (Believe They) Have Soft Budgets? Evidence on the Effects of Ownership and Decentralization in Mongolia," Journal of Comparative Economics, Elsevier, vol. 28(2), pages 219-246, June.
    9. Kornai, J, 1979. "Resource-Constrained versus Demand-Constrained Systems," Econometrica, Econometric Society, vol. 47(4), pages 801-819, July.
    10. J. Kornai & E. Maskin & G. Roland., 2004. "Understanding the Soft Budget Constraint," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 12.
    11. Douglas Staiger & James H. Stock, 1997. "Instrumental Variables Regression with Weak Instruments," Econometrica, Econometric Society, vol. 65(3), pages 557-586, May.
    12. Dahlberg, M. & Johansson, E., 1999. "On the Vote Purchasing Behavior of Incumbent Governments," Papers 1999:24, Uppsala - Working Paper Series.
    13. J. Dominitz & C. F. Manski, "undated". "Using expectations data to study subjective income expectations," Institute for Research on Poverty Discussion Papers 1050-94, University of Wisconsin Institute for Research on Poverty.
    14. Murphy, Kevin M & Topel, Robert H, 2002. "Estimation and Inference in Two-Step Econometric Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 88-97, January.
    15. Adrian Pagan, 1986. "Two Stage and Related Estimators and Their Applications," Review of Economic Studies, Oxford University Press, vol. 53(4), pages 517-538.
    16. Nelson, Charles R, 1975. "Rational Expectations and the Estimation of Econometric Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 16(3), pages 555-561, October.
    17. Charles F. Manski, 1993. "Identification of Endogenous Social Effects: The Reflection Problem," Review of Economic Studies, Oxford University Press, vol. 60(3), pages 531-542.
    18. Bo E. Honoré & Ekaterini Kyriazidou, 2000. "Panel Data Discrete Choice Models with Lagged Dependent Variables," Econometrica, Econometric Society, vol. 68(4), pages 839-874, July.
    19. Jonathan A. Rodden & Gunnar S. Eskeland (ed.), 2003. "Fiscal Decentralization and the Challenge of Hard Budget Constraints," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262182297, January.
    20. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-247, February.
    21. Anderson, T. W. & Hsiao, Cheng, 1982. "Formulation and estimation of dynamic models using panel data," Journal of Econometrics, Elsevier, vol. 18(1), pages 47-82, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Tyrefors, Björn, 2006. "Do Politicians Free-ride? - an empirical test of the common pool model," SSE/EFI Working Paper Series in Economics and Finance 626, Stockholm School of Economics, revised 28 Feb 2007.
    2. Kothenburger, Marko, 2007. "Ex-post redistribution in a federation: Implications for corrective policy," Journal of Public Economics, Elsevier, vol. 91(3-4), pages 481-496, April.
    3. Marie-Laure Breuillé & Thierry Madiès & Emmanuelle Taugourdeau, 2007. "Fiscal federalism and soft budget constraint: does the nature of public spending matter?," EconomiX Working Papers 2007-16, University of Paris Nanterre, EconomiX.
    4. Crivelli, Ernesto & Staal, Klaas, 2006. "Size and soft budget constraints," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 172, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    5. Fabio Padovano, 2014. "Distribution of transfers and soft budget spending behaviors: evidence from Italian regions," Public Choice, Springer, vol. 161(1), pages 11-29, October.
    6. Wildasin, David E., 2004. "The Institutions of Federalism: Toward an Analytical Framework," National Tax Journal, National Tax Association;National Tax Journal, vol. 57(2), pages 247-272, June.
    7. Bouton, Laurent & Gassner, Marjorie & Verardi, Vincenzo, 2008. "Redistributing income under fiscal vertical imbalance," European Journal of Political Economy, Elsevier, vol. 24(2), pages 317-328, June.
    8. Thomas Aronsson & Sören Blomquist, 2008. "Redistribution and Provision of Public Goods in an Economic Federation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(1), pages 125-143, February.
    9. Herold, Katharina, 2009. "Intergovernmental grants and financial autonomy under asymmetric information," FiFo Discussion Papers - Finanzwissenschaftliche Diskussionsbeiträge 09-2, University of Cologne, FiFo Institute for Public Economics.
    10. Sören Blomquist & Vidar Christiansen, 2008. "Taxation and Heterogeneous Preferences," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 64(2), pages 218-244, June.
    11. Fabio Padovano, 2011. "Causes and Consequences of Bailing out Expectations of Subcentral Governments: Theory and Evidence from the Italian Regions," Economics Working Paper Archive (University of Rennes 1 & University of Caen) 201128, Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS.
    12. Ernesto Crivelli & Klaas Staal, 2013. "Size, spillovers and soft budget constraints," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 20(2), pages 338-356, April.
    13. Zarko Kalamov & Klaas Staal, 2016. "Public debt, bailouts, and common bonds," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 23(4), pages 670-692, August.
    14. Marie-Laure Breuillé & Thierry Madiès & Emmanuelle Taugourdeau, 2007. "Funding source and soft budget constraint," EconomiX Working Papers 2007-12, University of Paris Nanterre, EconomiX.
    15. Nadia Fiorino & Emma Galli & Ilaria Petrarca, 2012. "Corruption and Growth: Evidence from the Italian Regions," European Journal of Government and Economics, Europa Grande, vol. 1(2), pages 126-144, December.
    16. Bordignon, Massimo & Turati, Gilberto, 2009. "Bailing out expectations and public health expenditure," Journal of Health Economics, Elsevier, vol. 28(2), pages 305-321, March.

    More about this item

    Keywords

    Soft budget constraint; Bailout; Fiscal distress; Intergovernmental relations;

    JEL classification:

    • H70 - Public Economics - - State and Local Government; Intergovernmental Relations - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hhs:uunewp:2003_028. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Katarina Grönvall). General contact details of provider: http://edirc.repec.org/data/nekuuse.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.