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Signaling Fiscal Regime Sustainability

Francesco Drudi and Alessandro Prati
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Francesco Drudi: Banca d'Italia

No 335, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: This paper proposes a signaling model of fiscal stabilizations that offers a new perspective on why governments deviate from optimal tax smoothing. In our model, dependable - but not fully credible - governments have an incentive to tighten the fiscal regime when the signaling effect on credit ratings is larger (that is, when a sufficiently large stock of debt has been accumulated). At this point, they may deviate from tax smoothing in order to avoid being mimicked by weak governments. We show that a testable prediction of our model is that primary balances and debt stocks are complementary inputs in the credit rating function and we successfully test it on Irish, Belgian, and Danish data from the late 1970s to the early 1990s.

Keywords: fiscal policy; taxation; debt; credit; economic models (search for similar items in EconPapers)
JEL-codes: E62 H2 (search for similar items in EconPapers)
Date: 1998-09
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Related works:
Journal Article: Signaling fiscal regime sustainability (2000) Downloads
Working Paper: Signaling Fiscal Regime Sustainability (1999) Downloads
Working Paper: Signaling Fiscal Regime Sustainability (1998)
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