Abstract

This study develops a dynamic general equilibrium model to analyze how physical disasters amplify public debt in decentralized fiscal systems. Using a purely analytical model, we compare Markov (no commitment) and Ramsey (full commitment) equilibria. We find that disaster severity increases debt at both government levels. Crucially, the absence of commitment induces myopic spending and fiscal instability, while commitment enables efficient risk-sharing and sustainable debt trajectories through rules-based transfer systems. Our main contribution is to demonstrate analytically how commitment mechanisms in intergovernmental transfers can mitigate disaster-induced debt accumulation, providing a theoretical foundation for fiscal rules in decentralized systems.