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Soft budget constraint but no moral hazard? The Dutch local government bailout puzzle

Maarten Allers and Erik Merkus

No 13014-EEF, Research Report from University of Groningen, Research Institute SOM (Systems, Organisations and Management)

Abstract: The fiscal federalism and public choice literatures stress that government bailouts should be avoided as they increase the probability that governments incur unsustainable debt levels or take excessive risk (moral hazard problem). The current problems in the euro area seem to confirm this view. However, in the Netherlands, the law explicitly stipulates that local governments that are unable to balance their books will be bailed out. Surprisingly, this does not seem to create problems. Only few local governments apply for bailout, and the amounts they receive are modest. We analyze the Dutch case and discuss possible explanations for this apparent anomaly. We test empirically if voters punish financial mismanagement in local governments, but find no evidence for this hypothesis.

Date: 2013
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