(97%) of the actual change in central (local) debt during 1988–1996, compared with 17% (129%) in the baseline. Overall, this alternative calibration delivers similar changes in total government debt as the baseline: decentralization accounts for 37% of total government debt changes during 1988–1996, and 24% during 1996–2006.

**Table 8:** Counterfactual Experiment with alternative local and central debt interest elasticities

|||1988–19|96||1996–20|06|
|---|---|---|---|---|---|---|
||(1)|(2)|(3)|(4)|(5)|(6)|
|Moments|1988|1996|Counterfactual<br>|1996|2006|Counterfactual<br>|
||||1996 (%)|||2006 (%)|
|Local debt|0.062|0.130|0.128 (97%)|0.130|0.122|0.116 (179%)|
|Central debt|0.338|0.615|0.401 (23%)|0.615|0.336|0.559 (20%)|
|Total government debt|0.400|0.745|0.529 (**37%**)|0.745|0.458|0.675 (**24%**)|

Note: Using _ψb_ = 0.05 and _ψd_ = 0.01. All other model parameters are re-calibrated. Calibration strategy is identical to the baseline. Total government debt (also known as “general government debt”) is the sum of local and central government debt. Counterfactual experiments use revenue ( _e_ and _f_ ) and spending responsibility share ( _θ_ ) values from end year, and keep all other parameters at their starting year values. Numbers in **parentheses** show the percent of debt changes that is explained by decentralization. All debt levels are normalized by national GDP.

# **4.3.3 Alternative calibration of constrained regions’ share and debt limit:** 1 _− μ_ **and** _B_<sup>_o_</sup>

In the baseline calibration, we use half of the regions (7 out of 15) with the lowest debt level and volatility in the data to proxy for the _constrained regions_ in the model. This gives the share of constrained regions 1 _− μ_ = 0.2 and their debt limit _B_<sup>_o_</sup> = 0.04. As an alternative calibration, we use 9 out of 15 regions with the lowest and most stable debt levels to proxy for the group of constrained regions. This yields 1 _− μ_ = 0.4 and _B_<sup>_o_</sup> = 0.046. With this set of ( _μ_ , _B_<sup>_o_</sup> ), we re-calibrate the model. We find that changing _μ_ and _B_<sup>_o_</sup> has little effect on the results from the counterfactual experiment once parameters are re-calibrated to match the moments in each year. Appendix I.4 reports the full calibration and results. To summarize, decentralization explains 39% of the increase in total government debt from 1988 to 1996, and 15% of the decrease in total government debt from 1996 to 2006.

# **4.3.4 Effect of a larger negotiation parameter** _ε_

The jointly calibrated negotiation parameter _ε_ has a sizeable impact on the Markov equilibrium debt levels. Figure 10 shows that holding other parameters at their calibrated values, both the central and total local debt levels increase with _ε_ . This is because as _ε_ increases, _τ_ becomes more redistributive, and so the central government is more willing to increase _τ_ to subsidize unconstrained regions. Higher _ετ_ encourages local governments to borrow more, and the central government also has to borrow more to help finance the higher total transfers.

A natural question is how _ε_ affects the results from the counterfactual experiment. We perform the counterfactual exercises using a larger _ε_ value (0.1) than the baseline (0.014), keeping all other 36