* Alexander Fink Department of Economics, George Mason University email: email@example.com. Thomas Stratmann Department of Economics, George Mason University email: firstname.lastname@example.org. We would like to thank Thies Büttner for helpful comments and suggestions.
Institutionalized Bailouts and Fiscal Policy: Consequences of Soft Budget Constraints
Article first published online: 18 JUL 2011
© 2011 Blackwell Publishing Ltd
Volume 64, Issue 3, pages 366–395, August 2011
How to Cite
Fink, A. and Stratmann, T. (2011), Institutionalized Bailouts and Fiscal Policy: Consequences of Soft Budget Constraints. Kyklos, 64: 366–395. doi: 10.1111/j.1467-6435.2011.00511.x
- Issue published online: 18 JUL 2011
- Article first published online: 18 JUL 2011
States have soft budget constraints when they can expect a bailout by the federal government in the event of a financial crisis. This gives rise to incentives for unsound state fiscal policy. We test whether states with softer budget constraints have higher debts and deficits, receive more bailout funds, spend funds less efficiently, and are more likely to allocate funds to programs benefiting special interests. Exogenous variation in soft budget constraints across states and over time allows the identification of the effect of budget constraint softness on state fiscal policy. We take advantage of the fact that in Germany the states' political influence per state citizen is exogenous and varies because voting weights differ in the upper chamber of the German parliament. The stronger the political influence per state citizen, the softer the budget constraint. We show that states with softer budget constraint have higher deficits and debts, and receive more bailout funds. Further, overrepresented states are less efficient in spending public funds and are more prone to respond to rent seeking by interest groups.