Public Financing Under Balanced Budget Rules

Minjie Deng ()
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Minjie Deng: Simon Fraser University, https://www.sfu.ca/economics/about/faculty/current/minjie-deng.html

Discussion Papers from Department of Economics, Simon Fraser University

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. Our quantitative analysis suggests that implementing a BBR in Illinois could dramatically decrease the state bond spread, lower the debt, and improve welfare three years after the policy change.

Date: 2024-10
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