The paper emphasizea the role of institurions and incentives in the
presence of externalities. An economy with multiple public decision makers
is likely to experience 'overspending," "undertaxing," "overborrowing," and
"overinflation" unless effective institutions exist for overcoming
coordination failure. External financing may weaken incentives for
adjustment over the longer run unless assistance is made conditional on
fundamental institutional reforms. The paper also analyses reforms that
strengthen incentives to provide effort. Uncertainty regarding future taxes
reduces present effort and the responsiveness of output to market signals.
In addition, the paper addresses the adverse effects of bank insurance and
soft budget constraints.
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