Signaling Fiscal Regime Sustainability
38 Pages Posted: 11 Feb 2006
Date Written: July 1999
This paper proposes a signaling model that offers a new perspective on why governments deviate from optimal tax smoothing and delay debt stabilization. In our model, dependable - but not fully credible - governments have an incentive to tighten the fiscal regime when the signaling effect on credit ratings is larger (that is, when a sufficiently large stock of debt has been accumulated). At this point, they may deviate from tax smoothing not to be mimicked by weak governments. The model predicts that primary balances and debt stocks are complementary inputs in the credit rating function as tests on Italian, Irish, Belgian, and Danish data show.
Keywords: signaling, fiscal stabilization, tax smoothing, debt sustainability, credit ratings
JEL Classification: E63, H6, F22
Suggested Citation: Suggested Citation