Signaling fiscal regime sustainability

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 i ncentive to tighten the fiscal regime when the signaling effect on credit r atings 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. We show that a testable prediction of our mo del is that primary balances and debt stocks are complementary inputs in th e credit rating function and we successfully test it on Italian, Irish, Bel gian, and Danish data. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: E63; H6; F22.