The role of matching grants as a commitment device in the federation model with a repeated soft budget setting

Abstract

This paper revisits the soft budget versus the hard budget constraint in federations. By extending Besfamille and Lockwood (Int Econ Rev 49:577–593, 2008), who examine a case where the soft budget is ex ante favorable, we consider a model that allows the federal government to use a matching grant as an ex post policy instrument. We establish that this instrument acts as a commitment device and may improve social welfare compared with the situation in which the government’s ex ante policy options are limited to a hard or soft budget.