State restrictions on local debt: Their role in preventing default |
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| Affiliation: | 1. University of Alberta, Department of Economics, Henry Marshall Tory Building 7-25, Edmonton, AB T6G 2H4, Canada;2. International College of Economics and Finance, NRU HSE, Shabolovka 26, Moscow 119049, Russia;1. Federal Reserve Bank of Philadelphia, Ten Independence Mall, Philadelphia, PA 19106, United States of America;2. School of Economics, Drexel University, 3220 Market St., Philadelphia, PA 19147, United States of America;1. Department of Innovation and Organizational Economics, Copenhagen Business School, Copenhagen, Denmark;2. Department of Business Administration and Marketing, University of Huelva, Huelva, Spain;3. Department of Economics, University of Huelva, Huelva, Spain |
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| Abstract: | Default by a local government can impose a negative externality upon other localities within a state because the state's ability to enforce debt repayment depends upon the proportion of municipalities favoring repayment. Localities benefit from maintaining their state's reputation for enforcement. Hence, jurisdictions not wishing to default favor enforcement of repayment by other jurisdictions. A debt limit increases support for enforcement by reducing the proportion of municipalities preferring default. We characterize when such a limit is optimal. We also examine the role of ‘special districts’, which typically neither are subject to a debt ceiling nor fully backed by the jurisdiction. |
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