Preventing Fiscal Crises under Decentralization: Intergovernmental Policies and Institutions

Ryota Nakatani

No 2025/087, IMF Working Papers from International Monetary Fund

Abstract: What instruments can governments deploy to prevent fiscal crises in decentralized fiscal systems? This analysis reveals that good public sector institutions, controls by the central government over local fiscal balances and borrowing, and intergovernmental transfers could be effective instruments for reducing the probability of a crisis. Strengthening good institutions mitigates the unwanted effects of devolution on fiscal unsustainability by inhibiting allocative inefficiencies caused by the moral hazard of governments. Expenditure decentralization to local governments increases the probability of a crisis only when local governments run large budget deficits, indicating that controls by the center over the local budget balance or borrowing ability may help to avoid overspending and the resulting excessive indebtedness. Subnational fiscal rules and administrative constraints also reduce the probability of a crisis. Intergovernmental transfers are associated with a lower probability of a fiscal crisis because they can play a role in interregional risk sharing among subnational governments.

Keywords: Fiscal Crisis; Decentralization; Intergovernmental Transfers; Subnational Fiscal Rules; Administrative Constraints; Corruption; Spending decentralization; expenditure decentralization; borrowing ability; revenue decentralization; probability of a crisis; Fiscal federalism; Government debt management; Government asset and liability management; Global (search for similar items in EconPapers)
Pages: 36
Date: 2025-05-09
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