IMF Working Papers

Preventing Fiscal Crises under Decentralization: Intergovernmental Policies and Institutions

By Ryota Nakatani

May 9, 2025

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Format: Chicago

Ryota Nakatani. "Preventing Fiscal Crises under Decentralization: Intergovernmental Policies and Institutions", IMF Working Papers 2025, 087 (2025), accessed May 11, 2025, https://doi.org/10.5089/9798229009089.001

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

What instruments can governments deploy to prevent fiscal crises in decentralized fiscal systems? This analysis reveals that good public sector institutions, controls by the central government over local fiscal balances and borrowing, and intergovernmental transfers could be effective instruments for reducing the probability of a crisis. Strengthening good institutions mitigates the unwanted effects of devolution on fiscal unsustainability by inhibiting allocative inefficiencies caused by the moral hazard of governments. Expenditure decentralization to local governments increases the probability of a crisis only when local governments run large budget deficits, indicating that controls by the center over the local budget balance or borrowing ability may help to avoid overspending and the resulting excessive indebtedness. Subnational fiscal rules and administrative constraints also reduce the probability of a crisis. Intergovernmental transfers are associated with a lower probability of a fiscal crisis because they can play a role in interregional risk sharing among subnational governments.

Subject: Balance of payments, Budget planning and preparation, Current account balance, Expenditure, Fiscal federalism, Fiscal policy, Fiscal rules, Government asset and liability management, Government debt management, Public debt, Public financial management (PFM), Revenue administration

Keywords: Administrative Constraints, Budget planning and preparation, Corruption, Current account balance, Decentralization, Fiscal Crisis, Fiscal federalism, Fiscal rules, Fiscal stance, Government asset and liability management, Government debt management, Intergovernmental Transfers, Subnational Fiscal Rules

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