Working Paper Series, Helmut Schmidt University Hamburg, Department of Economics 160
In the existing literature, fiscal policy in times of budget crises is considered above all from an empirical point of view. Until now, no model explaining the processes and forces at work has been developed. This article closes this gap. The model presented is based on the theory of political business cycles and the market discipline hypothesis. Unemployment, the voters' preference for a sustainable deficit policy and the probability of a sovereign default are the determinants influencing the deficit. As a result the deficit falls high if fiscal policy is effective in reducing unemployment, if voter prefer deficits rather than balanced budgets, if financial markets do not react to lasting deficits and if the natural rate of unemployment is high.
Budget Consolidation Debt Crisis Political Business Cycles Market Discipline Hypothesis Economic Voting