Public Financing Under Balanced Budget Rules

59 Pages Posted: 27 Jun 2022 Last revised: 13 Jun 2024

See all articles by Minjie Deng

Minjie Deng

Simon Fraser University, Department of Economics

Chang Liu

National University of Singapore (NUS), Department of Economics

Date Written: February 1, 2022

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. Calibrated to Illinois, our quantitative analysis suggests that implementing a BBR could dramatically decrease the state bond spread, gradually lower the debt, and improve welfare in the long run.

Keywords: Public financing, balanced budget rule, sovereign default risk, state government, fiscal rule

JEL Classification: E62, F34

Suggested Citation

Deng, Minjie and Liu, Chang, Public Financing Under Balanced Budget Rules (February 1, 2022). Available at SSRN: https://ssrn.com/abstract=4140495 or http://dx.doi.org/10.2139/ssrn.4140495

Minjie Deng (Contact Author)

Simon Fraser University, Department of Economics ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

HOME PAGE: http://www.minjiedeng.me/

Chang Liu

National University of Singapore (NUS), Department of Economics ( email )

Singapore
Singapore

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