Sub-National Optimal Budget Allocation and Borrowing under Soft Budget Constraint

Ernesto Crivelli

No 24/2006, Bonn Econ Discussion Papers from University of Bonn, Bonn Graduate School of Economics (BGSE)

Abstract: Local governments have borrowed largely from the banking system to finance their deficits instead of responding to the rigors of bond markets. This paper analizes how sub-national governments optimally reallocate the provision of public goods and decide on borrowing, in a model where the banking system faces a soft budget constraint. In contrast with recent literature, sub-national governments allocate a higher (lower) than optimal amount of resources to consumption public goods (infrastructure investment) and overborrow if they expect the banking system to be bailed out. Controls on sub-national borrowing like the golden rule seem to be inefficient to avoid excesive indebtedness at state level.

Keywords: Fiscal federalism; soft budget constraints; local public investment; sub-national borrowing (search for similar items in EconPapers)
JEL-codes: H7 R5 (search for similar items in EconPapers)
Date: 2006
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bonedp:242006

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