Politicians and soft budget constraints

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Abstract

From the perspective of political economics the authors study the use of soft budget constraints. What happens if a partly partisan government confronts a budget crisis in a politically important sector, e.g. like the health care sector?. To what extent wants the government to make additional grants to the sector depends on economic conditions and on the preferences of the government, both unknown to the electorate. Thus, the government's budget response gives a signal of its preferences, and may thereby influence the probability that the government is re-elected. As a result, the handling of a budget crisis becomes inefficient even from an ex post point of view, in the sense that it does not react adequately to changing economic conditions.