Table of Contents

Multi-level Finance and the Euro Crisis

Multi-level Finance and the Euro Crisis

Causes and Effects

Studies in Fiscal Federalism and State-local Finance series

Edited by Ehtisham Ahmad, Massimo Bordignon and Giorgio Brosio

Representing a unique contribution to the analysis and discussion of the unfolding Eurozone crisis in terms of the relationship between central and local government, this book addresses a number of important fiscal and political economy questions. To what extent have local and regional governments contributed to the crisis? To what degree have subnational services and investments borne the brunt of the adjustments? How have multi-level fissures affected tensions between different levels of government from the supranational to the local? This volume covers these and many other critical issues that have been largely ignored despite their relevance.

Chapter 13: Incentives facing local governments in the absence of credible enforcement

Leo Fulvio Minervini and Annalisa Vinella

Subjects: economics and finance, public finance


Very often, financial crises precede sovereign debt crises. As crises occur, they require restructuring or, at least, containing government debt, which in turn challenges the sustainability of public finances. Following the 2008 and 2009 financial crises, the sustainability of public finances has been called into question in heavily indebted countries within the Euro zone, as well as others, some of which, such as Ireland and Spain, were well within Maastricht limits in 2007. Furthermore, as central and subcentral governments are mutually dependent, concerns have arisen – and do persist – about the effects of the former’s conduct and performance spilling over onto the latter, and vice versa. However, it is essential to disentangle financial crises caused by adverse macroeconomic shocks, which are beyond the governments’ control, from those caused by strategic behaviour, which depend on the decisions made by economic agents (von Hagen and Dahlberg, 2002). Sub- central governments (henceforth, SCGs) are little motivated to manage public resources efficiently if they expect the centre (CG) to provide financial aid and, perhaps, to bail them out, as the need arises. Essentially, the CG suffers from a lack of dynamic commitment. This commitment problem has long been known as one of soft budget constraint (SBC). The SBC concept was originally introduced by Kornai (1979, 1980) in his studies on socialist and transition economies under stress.

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