The Empirics of the Municipal Fiscal Adjustment

We summarize the literature that uses the vector error-correction model approach to analyze the dynamics of the municipal fiscal adjustment. The international comparison between samples collected from entire countries and specific regions reveals interesting similarities, but also remarkable differences. The main similarities are the fulfillment of the intertemporal budget constraint, the volatility of the budgetary components, and the importance of the intergovernmental transfers as an adjustment instrument. The most remarkable difference is the preponderant role of the own revenues in the USA, probably reflecting the larger fiscal autonomy of US municipalities. In most cases, the large municipalities seem to be more dependent on grants than their small counterparts, although this pattern is broken in Japan. Finally, partial evidence supporting the existence of moral hazard problems and the flypaper effect is provided.