Abstract
We revisit the relationship between the primary balances/GDP and debt/GDP ratios (fiscal reaction function, FRF), in the advanced economies, showing that using adequate tests and estimators leads to question the validity of the current consensus. Using data for 1961–2019, we find that long-run FRFs exist only in a small number of advanced economies (Belgium, Germany, Greece, Norway, Portugal and Sweden), with polynomial effects with fiscal fatigue only in Germany. These results warn against the widespread practice of estimating homogeneous polynomial panel FRFs. Limiting the sample to 1961–2007, thus excluding the 2008 crisis and its aftermath, FRFs hold also in Canada, Ireland, Italy (polynomial), Spain and USA, though not in Germany, and the coefficients are generally larger. Particularly, after 2008 European Union countries appear somehow to have been more likely to implement FRFs.
Highlights
The question if and how governments react to increases in public debt adjusting the primary balance has attracted considerable attention over the last decades
2 Given that we focus on the long-run fiscal reaction function (FRF), we do not discuss them in detail
European Union (EU) official documents remark that “Enforcement [...] was weak, resulting in serious fiscal imbalances in some EU countries, exposed when the economic and financial crisis struck in 2008.”6 Only after the 2011 sovereign debt crisis, “a satisfactory pace” has been precisely defined to mean that ”the gap between a country’s debt level and the 60% reference needs to be reduced by one 20th annually”
Summary
The question if and how governments react to increases in public debt adjusting the primary balance has attracted considerable attention over the last decades. The problem is that while the early studies (Bohn 1998, and before that, Trehan and Walsh 1991) carefully took into account the stochastic properties of the data, this is mostly not true for the more recent contributions, especially those taking a panel approach Given this background, our aim is to reach reliable conclusions on the FRF for the advanced economies. Our aim is to reach reliable conclusions on the FRF for the advanced economies To this end, we will test for the existence of the FRF as a long-run relationship using adequate techniques, which for the non-stationary case differ for linear and nonlinear specifications, a point totally ignored in the literature. The paper is organised as follows: in Sect. 2, we define the set-up, in Sect. 3, we describe that data and carry out some univariate preliminary analysis, in Sect. 4, we estimate the long-run FRFs and in Sect. 5 we draw some conclusions
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