Dynamic Commitment and the Soft Budget Constraint: An Empirical Test

23 Pages Posted: 25 May 2007

See all articles by Per Pettersson-Lidbom

Per Pettersson-Lidbom

Stockholm University - Department of Economics; Research Institute of Industrial Economics (IFN)

Date Written: May 3, 2007


This paper empirically tests whether the soft budget constraint is caused by a dynamic commitment problem, i.e., the inability of a supporting organization to commit itself not to extend more resources ex post to a budget-constrained organization than it was prepared to provide ex ante. It uses Swedish local governments as a testing ground since the central government provided 1,414 discretionary intergovernmental fiscal transfers over the period 1979-1992. The estimated soft-budget effect is substantial, on average; a local government increases its debt by 20 percent of going from a hard to a soft budget constraint.

Keywords: Dynamic commitment, credibility, rational expectations, intergovernmental fiscal transfers, instrumental variable strategies

JEL Classification: D78, D84, D99, H74, H77

Suggested Citation

Pettersson-Lidbom, Per, Dynamic Commitment and the Soft Budget Constraint: An Empirical Test (May 3, 2007). Available at SSRN: https://ssrn.com/abstract=988359 or http://dx.doi.org/10.2139/ssrn.988359

Per Pettersson-Lidbom (Contact Author)

Stockholm University - Department of Economics ( email )

Universitetsvägen 10 A
House A, floor 4 and 7
Frescati, Stockholm

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15

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