Default, reputation, and balanced-budget rules

Is a balanced-budget rule compatible with a government honoring its debt obligations? According to the conventional explanation, governments honor their debt obligations to maintain a good reputation for future borrowing. The ability to borrow is desirable because it allows for greater tax smoothing...

Full description

Saved in:
Bibliographic Details
Published in:Review of economic dynamics 2004-04, Vol.7 (2), p.382-405
Main Author: Stockman, David R.
Format: Article
Language:English
Subjects:
Budgeting
Debt management
Default
Economic models
Economic policy
Economic theory
Government
Reputations
Studies
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:Is a balanced-budget rule compatible with a government honoring its debt obligations? According to the conventional explanation, governments honor their debt obligations to maintain a good reputation for future borrowing. The ability to borrow is desirable because it allows for greater tax smoothing. However, a balanced-budget rule limits the ability to smooth taxes, rendering a large class of competitive equilibria not compatible with a government honoring its debt obligations. The reputation model predicts default as the equilibrium outcome under a balanced-budget restriction. Insofar as this prediction is falsified by empirical observation, mechanisms other than reputation must be at work.
ISSN:1094-2025
1096-6099
DOI:10.1016/j.red.2003.09.002