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How important is to place limits on specific categories of local public spending in order to prevent municipalities’ defaults? In this paper we consider Italian municipalities from 2000 to 2012. We use a logit model to investigate which of the main budget indicators (debt repayments, current budget equilibrium, amount of residuals and personnel costs) is relatively more important in affecting the default probability. Our results suggest that a 10% rise in the share of loan repayment over total spending leads to an increase in default probability by 2.6% on average. These findings are robust to alternative model specifications and the inclusion of fixed effects, time dummies and macroeconomic control variables. Our analysis thus shows that Italian municipalities seem to be on the default path when they are incapable to fully internalize the effects of issuing new debt today on the current equilibrium of tomorrow. To place limits on specific types of public spending seems to be relatively less important.

Determinants of fiscal distress in Italian municipalities