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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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  19. Cukierman, A. & Liviatan, N., 1989. "Optimal Accommodation By Strong Policymakers Under Incomplete Information," Papers 13-89, Tel Aviv.
  20. 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.
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  24. Torsten Persson & Lars E. O. Svensson, 1989. "Why a Stubborn Conservative would Run a Deficit: Policy with Time-Inconsistent Preferences," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 325-345.
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  26. 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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