Default, Reputation and Balanced-Budget Rules

David Stockman

Review of Economic Dynamics, 2004, vol. 7, issue 2, 382-405

Abstract: 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 of borrowing 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 competititve 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. (Copyright: Elsevier)

JEL-codes: E61 H21 H63 (search for similar items in EconPapers)
Date: 2004
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Citations: View citations in EconPapers (11)

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DOI: 10.1016/j.red.2003.09.002

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