Dynamic Commitment and the Soft Budget Constraint An Empirical Test

This paper develops an empirical framework for the problem of soft budgets which is explicitly based on 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 Swedish local governments are used as a testing ground since the central government distributed a large number of fiscal transfers The estimated soft-budget effect is economically significant on average a local government Increases its debt by more than 20 percent by going from a hard to a soft budget constraint (JEL D82, G32, L32)