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Signaling Fiscal Regime Sustainability

  • Alessandro Prati
  • Francesco Drudi

This paper proposes a signaling model that offers a new perspective on why governments deviate from optimal tax smoothing and delay debt stabilization. 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 not to be mimicked by weak governments. The model predicts that primary balances and debt stocks are complementary inputs in the credit rating function as tests on Italian, Irish, Belgian, and Danish data show.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 99/86.

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Length: 38
Date of creation: 01 Jul 1999
Date of revision:
Handle: RePEc:imf:imfwpa:99/86
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  1. 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.
  2. Drudi, F. & Prati, A., 1998. "Signaling Fiscal Regime Sustainability," Papers 335, Banca Italia - Servizio di Studi.
  3. Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of two Small Euopean Countries," Working Papers 89, Dipartimento Scienze Economiche, Universita' di Bologna.
  4. 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.
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  7. Harold L. Cole & James Dow & William B. English, 1994. "Default, settlement, and signalling: lending resumption in a reputational model of sovereign debt," Staff Report 180, Federal Reserve Bank of Minneapolis.
  8. Sutherland, Alan, 1995. "Fiscal Crises and Aggregate Demand: Can High Public Debt Reverse the Effects of Fiscal Policy?," CEPR Discussion Papers 1246, C.E.P.R. Discussion Papers.
  9. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 91-116, January.
  10. Herschel I. Grossman & John B. Van Huyck, 1985. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," NBER Working Papers 1673, National Bureau of Economic Research, Inc.
  11. Andrew Atkeson, 2010. "International lending with moral hazard and risk of repudiation," Levine's Working Paper Archive 200, David K. Levine.
  12. Robert J. Barro, 1986. "Reputation in a Model of Monetary Policy with Incomplete Information," NBER Working Papers 1794, National Bureau of Economic Research, Inc.
  13. 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.
  14. 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.
  15. Tabellini, Guido & Alesina, Alberto, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Scholarly Articles 3612769, Harvard University Department of Economics.
  16. Alesina, A. & Prati, A. & Tabellini, G., 1989. "Public Confidence And Debt Management: A Model And A Case Study Of Italy," Papers 5, California Los Angeles - Applied Econometrics.
  17. Alberto Alesina & Roberto Perotti, 1997. "Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects," IMF Staff Papers, Palgrave Macmillan, vol. 44(2), pages 210-248, June.
  18. Bertola, Giuseppe & Drazen, Allan, 1991. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," CEPR Discussion Papers 599, C.E.P.R. Discussion Papers.
  19. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  20. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
  21. V.V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans and mutual default," Staff Report 124, Federal Reserve Bank of Minneapolis.
  22. Persson, Torsten & Svensson, Lars E O, 1989. "Why a Stubborn Conservative Would Run a Deficit: Policy with Time-Inconsistent Preferences," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 325-45, May.
  23. Alberto Alesina & Roberto Perotti, 1995. "Fiscal Expansions and Fiscal Adjustments in OECD Countries," NBER Working Papers 5214, National Bureau of Economic Research, Inc.
  24. Alberto Alesina & Roberto Perotti, 1995. "The Political Economy of Budget Deficits," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 1-31, March.
  25. Drudi, Francesco & Prati, Alessandro, 1993. "Signalling Debt Sustainability," CEPR Discussion Papers 787, C.E.P.R. Discussion Papers.
  26. Cukierman, Alex & Liviatan, Nissan, 1991. "Optimal accommodation by strong policymakers under incomplete information," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 99-127, February.
  27. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
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