Soft budget constraints in a federation: the effect of regional affiliation

Willem Sas ()

Working Papers of Department of Economics, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven

Abstract: This paper revisits the soft budget constraint problem, pushing sub-central (state) borrowing to the limit in multi-tiered countries. Accounting for the institutional design and political practice common to many federations, bargaining and log-rolling are introduced to the analysis. In our intertemporal model, a federal legislature of regionally elected representatives bargains on federal grants going to the states. As a result, voters will elect federal candidates in favour of looser state public spending than otherwise expected. This strategic voting not only leads to overly generous bailout policies. Also, and compared to a setting where federal decision making does not follow from bargaining and regional affiliation, states over-borrow more inefficiently. Allowing for heterogeneity in state income and population does not affect this inefficient outcome. Lower relative per capita incomes even boost federal generosity and subsequent over-borrowing by the states.

Date: 2014-02
New Economics Papers: this item is included in nep-cdm, nep-pbe and nep-pol
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https://lirias.kuleuven.be/bitstream/123456789/441522/1/DPS1406.pdf

Related works:
Working Paper: Bailouts in a federation: A cooperative legislature at work (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:ete:ceswps:ces14.06

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