Public Financing Under Balanced Budget Rules

Minjie Deng and Chang Liu

Review of Economic Dynamics, 2025, vol. 56

Abstract: This paper analyzes the impact of a balanced budget rule (BBR) on government financing costs and its implications for the government balance sheet. Exploiting the variation in BBR implementation across US states, we find that states with more stringent BBRs exhibit significantly lower bond spreads and credit default swap spreads, demonstrating the crucial role of default risk. A sovereign default model, which features long-term debt, endogenous investment and output, as well as a BBR, aligns with the empirical result. Calibrated to Illinois, our quantitative analysis suggests that implementing a BBR could dramatically decrease the state bond spread, gradually lower the debt, and improve welfare in the long run. (Copyright: Elsevier)

Keywords: Public financing; balanced budget rule; sovereign default risk; state government; fiscal rule (search for similar items in EconPapers)
JEL-codes: E62 F34 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1016/j.red.2025.101275

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