Soft budget constraints and strategic interactions in subnational borrowing: Evidence from the German States, 1975–2005

Thushyanthan Baskaran

Journal of Urban Economics, 2012, vol. 71, issue 1, 114-127

Abstract: Cooperative federations are usually characterized by the existence of bailout guarantees and intergovernmental transfer schemes. This paper explores whether such features of cooperative federations lead to subnational soft budget constraints using panel data from the German States covering the 1975–2005 period. The methodology is based on the premise that subnational governments’ borrowing will exhibit vertical and horizontal strategic interactions if they operate under soft budget constraints. Therefore, a test for strategic interactions in subnational borrowing can be used to infer whether a cooperative federation like Germany is susceptible to soft budget constraints. The results suggest that state borrowing in Germany exhibited horizontal but not vertical interactions during the time-frame of the analysis. This indicates (i) that German States faced soft budget constraints and (ii) that they were more concerned about the likelihood of a bailout than about its volume.

Keywords: Fiscal federalism; Soft budget constraints; Strategic fiscal interactions (search for similar items in EconPapers)
JEL-codes: H30 H74 H77 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (55)

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Working Paper: Soft budget constraints and strategic interactions in subnational borrowing: Evidence from the German States, 1975-2005 (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:juecon:v:71:y:2012:i:1:p:114-127

DOI: 10.1016/j.jue.2011.07.003

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