The Real Effects of Local Government Indebtedness: Evidence from Toxic Loans

56 Pages Posted: 31 Oct 2023

See all articles by Boris Vallee

Boris Vallee

Harvard Business School - Finance Unit

Julien Sauvagnat

Bocconi University; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Date Written: May 23, 2023

Abstract

We examine the response from municipalities and their voters to a large and exogenous increase in municipal indebtedness. We show that municipalities with “toxic loans” on their balance sheet exhibit a large increase in their debt and interest expenses following the Great Financial Crisis, and a twice-as-large reduction in municipal investments. The reduction in investments is particularly pronounced for municipalities that are politically contested. Local taxes remain unaffected. These empirical findings are consistent with a model of municipal investment in which electoral competition act as a disciplinary device for local politicians, and highlight the economic and political nature of public indebtedness.

Suggested Citation

Vallee, Boris and Sauvagnat, Julien, The Real Effects of Local Government Indebtedness: Evidence from Toxic Loans (May 23, 2023). Proceedings of the EUROFIDAI-ESSEC Paris December Finance Meeting 2023, Available at SSRN: https://ssrn.com/abstract=4613823 or http://dx.doi.org/10.2139/ssrn.4613823

Boris Vallee (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

Julien Sauvagnat

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

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