The question of why regions, that cooperate in a federal union, overborrow—meaning that they issue more debt than would be beneficial from a point-of-view of intertemporal efficiency—is of utmost relevance in many contexts. Traditionally, the role of fiscal rules (i.e. caps on debt issuance levels with punishment payments upon violation) has been emphasized in overcoming the root of the problem: that central authorities in federal unions cannot commit to not use their funds to bail out overindebted members at the expense of other members. Dovis & Kirpalani, however, ask an important question: what happens if the central authority also cannot commit to enforcing the fiscal rules? In their paper, they show that if the central authority has a low reputation (i.e. low probability of enforcing the fiscal rules and the no-bailout-clause), fiscal rules are not only ineffective, but they can even lead to a higher debt issuance and exacerbate the overborrowing problem.
This report aims at outlining Dovis & Kirpalani’s reasoning for their central claim, thus sketching out their proofs and providing intuition for their results. Furthermore, a short assessment of their paper is provided, centering on validity and possible extensions.
Inhaltsverzeichnis (Table of Contents)
- KEY QUESTIONS, INSIGHTS AND RELATED LITERATURE
- THE MODEL
- MAIN RESULTS
- Delay of type revelation in the game without fiscal rules
- Early revelation upon binding fiscal rules and low reputation causes higher debt
- Fiscal rules promote fiscal discipline if reputation is high
- EXTENSION: EQUILIBRIUM RULES
- EMPIRICAL RESULTS: EFFECTIVENESS OF FISCAL RULES AND GOVERNMENT REPUTATION
- DISCUSSION
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This report aims to explain Dovis & Kirpalani's central claim by outlining their proofs and providing intuition for their results. It also includes a brief assessment of their paper, focusing on its validity and potential extensions.
- Overborrowing in federal unions
- The role of fiscal rules
- The impact of government reputation on fiscal discipline
- The free-rider problem
- The effectiveness of fiscal rules in practice
Zusammenfassung der Kapitel (Chapter Summaries)
- KEY QUESTIONS, INSIGHTS AND RELATED LITERATURE: This chapter discusses the phenomenon of overborrowing, particularly in federal states and unions. It examines game-theoretic frameworks used to understand free-rider problems and the lack of commitment in central authorities regarding debt mutualization. The chapter also highlights the traditional argument for fiscal rules as a solution to overborrowing and the potential for a central government to institute and enforce these rules.
- THE MODEL: This chapter introduces the model used by Dovis & Kirpalani, based on the Kreps and Wilson framework. It describes the structure of the game, including the players, their objectives, and the role of the central government. It also introduces the concept of government reputation and its influence on the effectiveness of fiscal rules.
- MAIN RESULTS: This section focuses on the key findings of the research, including:
- Delay of type revelation in the game without fiscal rules: This subsection explores the equilibrium outcome of the game without fiscal rules. It analyzes the government's decision-making process and the resulting equilibrium outcomes under different conditions.
- Early revelation upon binding fiscal rules and low reputation causes higher debt: This subsection examines the impact of fiscal rules on the equilibrium outcome when the government has low reputation. It explains how binding fiscal rules can increase the cost of enforcement and, in turn, lead to higher debt issuance.
- Fiscal rules promote fiscal discipline if reputation is high: This subsection analyzes the effectiveness of fiscal rules in a high-reputation scenario. It shows how fiscal rules can effectively promote fiscal discipline when the government has a high probability of enforcing them.
Schlüsselwörter (Keywords)
This paper centers on the key concepts of fiscal rules, government reputation, overborrowing, debt mutualization, free-rider problem, and game-theoretic models. It explores how the interaction between these factors affects fiscal discipline in federal unions.
- Quote paper
- Ulrich Roschitsch (Author), 2019, Fiscal Rules, Bailouts, and Reputation in Federal Governments, Munich, GRIN Verlag, https://www.grin.com/document/492634
