American Economic Review Vol. 88 No. 5 1998
Federalism and the Soft Budget Constraint
Abstract
The government's incentives to bail out inefficient projects are determined by the trade-off between political benefits and economic costs, the latter depending on the decentralization of government. Two effects of federalism are derived: First, fiscal competition among local governments under factor mobility increases the opportunity costs of bailout and thus serves as a commitment device (the "competition effect"). Second, monetary centralization, together with fiscal decentralization, induces a conflict of interests and thus may harden budget constraints and reduce inflation (the "checks and balance effect"). Our analysis is used to interpret China's recent experience of transition to a market economy.
- Volume
- 88
- Issue
- 5
- Pages
- 1143-1162
- Sources
- bibtex:phds-export.bib