Assist or desist? Conditional bailouts and fiscal discipline in local governments

•We examine the effect of a conditional bailout on fiscal discipline in the Swedish municipalities.•We find a restraining effect on per capita costs for some bailed-out municipalities.•On average, the per capita fiscal surplus is higher after the bailout.•We find little evidence of lower fiscal discipline after the bailout.

Central government bailouts of local governments are commonly viewed as a recipe for local fiscal indiscipline, as local governments learn that the center will come to the rescue in times of trouble. However, little is known about the consequences of bailouts granted conditional on local governments first making efforts to improve the situation. We examine a case in which the Swedish central government provided conditional grants to 36 financially troubled municipalities. We use the synthetic control method to identify suitable comparison units for each of the 36 municipalities. To compare the development of costs and the fiscal surplus of admitted municipalities to that of their most similar counterparts during the decade after the program, we then estimate fixed effects regressions on the resulting sample. The analysis suggests that conditional bailouts did not erode, and may even have improved, fiscal discipline.