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Abstract

This thesis focuses on the expenditure and budget management decisions of governments. The first chapter of this thesis studies the optimal decision of a fiscal authority when faced with a liquidity crisis in its banking study. I consider the effect of a 'rules' based framework for bailing out banks faced with a short-fall of liquidity, and find that an ex-ante credible commitment to helping banks only when they have leverage below a certain maximum threshold acts as an automatic incentive to for banks to hold a greater quantum of liquid assets than they would otherwise. The second chapter focuses on the trade-off between political gains and economic incentives in a federal union. I find that if the central government is allowed to make discretionary transfers to a state government, then they have an incentive to transfer larger amounts to those states in which the same political party is in power as the one in the centre. I test this model using data from India, and find that political incentives do affect the quantum of transfers from central to state governments, and further, that these transfers have a significant negative effect on the fiscal balance of the state. A related issue is how these transfers are used, which I study in the third chapter. I look into state government spending in various sectors of the economy in order to determine whether the state governments are actually responsive to the needs of their citizens, for example poverty alleviation, or if they are politically motivated. The thesis, as a whole, highlights the importance of studying the incentives institutions face while formulating fiscal policy.

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