Panel Paper: Political and Institutional Factors In Making Fiscal Policy During Crisis: Evidence From U.S. States

Saturday, November 10, 2012 : 2:45 PM
Jefferson (Sheraton Baltimore City Center Hotel)

*Names in bold indicate Presenter

Sounman Hong, Harvard University

Economic recession and financial uncertainty across the industrial countries of the world have sparked a widespread debate about the effectiveness of balanced-budget rules in curtailing deficits. This paper seeks to explain the functions of balanced-budget rules, especially during an economic recession, with the help of recent experiences of the American states. This study examines whether the effectiveness of the rules depends on economic conditions of the state. Findings suggest that (1) balanced-budget rules are more effective in closing deficit gaps during fiscal crisis than during “normal” times, and also that (2) divided or left-leaning political systems are less able to react to unexpected fiscal shocks especially during fiscal crisis. This result implies that the costs of reaching political consensus are higher when the government is divided or public sector union are strong as a significant part of fiscal adjustments generally entail cuts in government wages and transfers, and these costs become a more