Intertemporal Government Budget Constraint Research Articles

Fiscal Sustainability, Fiscal Debt and Economic Growth in the South Asian Region

The issue of fiscal sustainability in South Asia is paramount since the tide of economic liberalization in the 1980s and given its ballooning public debt. Using annual data for 1960–2019, we perform a battery of tests to determine fiscal sustainability in Sri Lanka, India, and Pakistan. We adopt the Bohn (1998) model by estimating a fiscal reaction function (FRF). The model is derived from the theoretical foundation that shows a sufficient condition for satisfying the intertemporal government budget constraint whereby the primary balance reacts positively to the lagged debt-to-GDP ratio. A positive response to the primary balance suggests that the government is counteracting the increase in fiscal debt. The results show evidence of fiscal sustainability for the model in all three countries. We relax the assumption of a constant-parameter linear fiscal rule and allow nonlinearity in the FRF by (1) incorporating the Markov-switching fiscal rule into the FRF and (2) estimating a time-varying parameter model of the FRF. The Markov-switching model identifies two fiscal regimes described by periods of sustainable and unsustainable fiscal policies. The model also yields transition probabilities and the expected duration of the regimes, which we use to evaluate the No-Ponzi game condition. The results show that while this condition is satisfied, the long-term debt-stabilizing condition fails to hold. The time-varying parameter model of the FRF shows different episodes when the primary balance reacts positively or negatively to the lagged debt-to-GDP ratio, corroborating the results of the Markov-switching model. We then examine the impact of fiscal debt on growth in these regimes using a threshold regression model. For fiscal debt above some threshold, that is 78 percent of the GDP in Sri Lanka, 67 percent of GDP in India and 58 percent in Pakistan, economic growth in these countries tends to decline. Our results suggest that while fiscal stance in these economies is sustainable, the governments need to curtail the growing fiscal debt below the optimal threshold level to promote economic growth.

Globalization of capital, erosion of economic policy sovereignty, and the lessons from John Maynard Keynes

This article observes that current macroeconomic policy modeling, centered on domestic agents or agencies, fails to recognize the role that global investors play in determining the space for effective domestic macroeconomic policies, and argues that these actors must be brought to the center of macro analysis if one wants to understand how policies work in the global financial context. The article describes the key features of global investors, discusses their power to determine the prices at which public-sector liabilities (money and debt) trade in the international markets, and considers how this power affects the effectiveness of macroeconomic policies by national governments. As a result, no government is truly sovereign in a globalized world, and every government is subject to an intertemporal budget constraint (IBC), although, of course, not all governments are born equal and not all IBCs are equally binding: government IBCs are elastic, endogenous to global investor decisions, and yet ineluctable. The article concludes that choosing the correct country policy stance in today's financial global context would benefit from revisiting some of the key policy lessons that John Maynard Keynes left with us, considering his deep knowledge of global financial markets and how they affect country economies.

Is fiscal austerity really self‐defeating?

AbstractThis paper analyzes local and global equilibrium dynamics in an optimizing endogenous growth model under expenditure‐based fiscal austerity feedback policies expressed relative to the private capital stock—prescribing spending cuts in reaction to public debt accumulation. Because the present value of equilibrium primary surpluses turns to be a nonlinear function of debt, two steady state equilibria are shown to emerge, one exhibiting low debt and high growth, one exhibiting high debt and low growth. Local analysis reveals that the low‐debt/high‐growth steady state is saddle‐path stable while the high‐debt/low‐growth steady state is unstable—the latter thus indicating the possibility of self‐defeating austerity, characterized by off‐equilibrium upward spirals in debt because of persistent policy‐induced adverse effects on growth dividends and fiscal revenues. However, when global nonlinear dynamics are taken into account, it is demonstrated that the two steady states are endogenously connected. In particular, global analysis reveals that even if the high‐debt/low‐growth steady state is locally unstable, there exists a unique and possibly nonmonotonic saddle connection making the economy converge to the low‐debt/high‐growth steady state. The existence of the saddle connection guarantees global determinacy of perfect foresight equilibrium should the high‐debt/low‐growth steady state be a node, ruling out multiple explosive paths incompatible with the government's intertemporal budget constraint and the private agents' transversality condition. The foregoing results are robust with respect to the adoption of an output‐based—rather than a capital‐based—policy function as long as the rule is nonlinear and sufficiently reactive to debt changes.

Does fiscal stance affect inflation expectations? Evidence for European economies

According to the fiscal theory of the price level, in a non-Ricardian regime, high public debt should lead to a price-level increase so as to fulfill intertemporal government budget constraint. Forward-looking agents should anticipate this rise by pushing up their inflation expectations. This study tests the above hypothesis by analyzing the impact of fiscal sustainability on the formation of inflation expectations by private-sector agents – consumers and professional forecasters – in European countries. In the study, we estimate models of inflation expectations, and we include public debt among the explanatory variables. The novelty of this study lies in our analysis of whether the relationship between public debt and inflation expectations is affected by the degree to which fiscal policy is sustainable in European economies. We find that fiscal stance influences the inflation expectations of consumers and professional forecasters. Contrary to intuition, the reaction of consensus economic forecasts to public debt in countries with sustainable fiscal policies seems stronger than in economies with less disciplined fiscal policies. This may suggest that fiscal authorities are constrained by the way in which private-sector agents form their expectations, conducting more responsible fiscal policy in countries where the reaction of economic agents to fiscal variables is stronger.

Accrual Accounting and the Government's Intertemporal Budget Constraint

In its standard form, the intertemporal budget constraint requires the present value of a government's future primary cash surpluses to be at least equal to the value of its outstanding debt. In an effort to help link accrual accounting to fiscal analysis, this paper shows how the constraint can also be expressed in terms of the surpluses and balance sheets of the accrual‐based accounts and fiscal statistics that are increasingly supplementing and sometimes replacing traditional cash‐only accounting.

Tracking fiscal discipline. Looking for a PIIGS on the wing

This paper revisits fiscal sustainability conditions by relaxing the long-run time-invariance restriction on the parameters commonly imposed in the existing literature. For this purpose, we propose to extend the stock-flow econometric analysis, which bridge the use of government's intertemporal budget constraint as well as a government's fiscal manoeuvre, by allowing time-varying multicointegration. We applied the procedure to the Portuguese case. We found that fiscal practice has taken various directions in this country since the end of the 90s, involving different situations regarding fiscal sustainability.

Assessing public debt sustainability for Costa Rica using the fiscal reaction function

This paper assesses Costa Rica's public debt sustainability empirically using three complementary approaches: the calculation of the debt-stabilizing primary fiscal balance obtained from the government's intertemporal budget constraint, the estimation of the parameters of a fiscal policy reaction function (FRF) following the methodology originally proposed by proposed by Bohn (2007); and the estimation of fan charts for the primary fiscal balance and public debt expressed as shares of GDP following the approach proposed by Celasun et al. (2006). With annual data from the period 1974–2018, we find that debt has been unsustainable for specific long- and short-term episodes. For the most recent observations, the conclusion is that debt trajectory is unsustainable. Given that a major fiscal reform was approved at the end of 2018, an uncertainty evaluation of its impact on the primary balance's adjustment path until 2023 and 2030 is included using the official estimated reform projections. The results indicate that the maximum level of the debt ratio will be 68% in 2026, after which this upward trend reverses.

Bond Convenience Yields in the Eurozone Currency Union

This paper analyzes bond convenience yields in a currency union. The intertemporal government budget constraint requires member countries' bond convenience yields and default spreads to adjust in response to shocks to their government surpluses. In the data, adjustments to convenience yields explain a larger fraction of the variation in Eurozone bond yields than default spreads. Higher convenience yields are correlated with stronger fiscal conditions both in the cross-section and in the time series. These findings imply large fiscal costs especially on the peripheral countries. If all Eurozone countries could have issued sovereign bonds at the same convenience yields as Germany, they would have raised an extra 281 billion euros in cumulative revenues from bond issuance between 2003 and 2020, representing 2.6% of 2020 Eurozone GDP.

Sustainability of the fiscal imbalance and public debt under fiscal policy asymmetries in Sri Lanka

This paper investigates the sustainability of Sri Lanka’s fiscal imbalance and public debt. To test for sustainability of the fiscal imbalance, the study applies a symmetric ARDL (autoregressive distributive lag) technique to estimate a government intertemporal budget constraint. And to test for sustainability of public debt, it applies an asymmetric ARDL technique to estimate a fiscal reaction function, which allows for differential responses in the primary budget balance depending on whether shocks to regressors are positive or negative. Annual data for the period 1961–2018 are used in the estimations. The results indicate that Sri Lanka’s fiscal management is inconsistent with strong form sustainability, which requires that expenditures not grow faster than revenues. However, estimation of the fiscal reaction function finds robust evidence for fiscal policy asymmetries. Evidence emerges that Sri Lanka’s fiscal policy stance is procyclical with strong stabilization tendencies in economic expansions that are not sustained in contractions. Against upsurges in the debt-to-GDP ratio, authorities are found to pursue fiscal consolidation, thus suggesting weak form sustainability.

The Fiscal Theory of the Price Level in a Non-Ricardian Economy

The Fiscal Theory of the Price Level (FTPL) establishes that the general level of prices is determined at equilibrium in order to satisfy the intertemporal government budget constraint. Importantly, in a representative agent framework, this theory requires that the present value of future primary surpluses has to be strictly positive. In a richer framework where the economy is non-Ricardian—an overlapping generations of infinitely-lived agents model—and where the monetary policy is constrained by the Zero Lower Bound (ZLB) on nominal interest rates, we show that the FTPL case arises endogenously, even when exogenous primary surpluses are null. In such a framework, a bubble-like component of government debt induces the price level determinacy by the fiscal policy and affects its equilibrium level.

Anchor me: the benefits and challenges of fiscal responsibility

This paper discusses the benefits and challenges of implementing a rule‐based fiscal responsibility framework, using the Philippines as a case study. It estimates structural measures of the fiscal stance over the period 1980–2016 and applies a stochastic simulation model to determine the optimal set of fiscal rules. The empirical analysis indicates that discretionary fiscal policy has been procyclical, and the degree of procyclicality has increased in recent years. While the national government's nonbinding ceiling on the overall budget deficit is helpful, it does not constitute an appropriate operational target to guide fiscal policy over the economic cycle and necessarily ensure that the fiscal stance meets the government's intertemporal budget constraint. To this end, I use stochastic simulations and show the macroeconomic benefits of a well‐designed fiscal responsibility law that enshrines explicit fiscal rules designed for countercyclical policy and long‐term debt sustainability and an independent fiscal council that improves accountability and transparency.

SUSTAINABILITY OF FISCAL POLICY: ESTIMATING A FISCAL REACTION FUNCTION FOR TURKEY

In this study a Fiscal policy analysis is used for Turkey between the periods 2006:1-2016:2 to assess the sustainability of fiscal policy. A fiscal reaction function is estimated to analyze the effects of public debt and fluctuations in GDP on the primary balance. The fiscal reaction function is obtained from the intertemporal government budget constraint in order to depict the behaviour of government towards the public debt. The results suggest that the primary budget balance reacts significantly to the previous increase in GDP gap. http://dx.doi.org/10.17130/ijmeb.2018239936

An Empirical Analysis of the Sustainability of Public Debt in Ghana

Governments have the zeal to meet the developmental needs of their countries but due to their inability to raise the necessary revenue to commensurate their expenditure, the fiscal balance of their countries has deteriorated. The surge in the public debt of Ghana has caused much anxiety on the sustainability of such fiscal measures. The study is set out to investigate if Ghana’s debt is sustainable in the long-run and also ascertain if the solvency condition holds for the country. Secondary data spanning from 1990 to 2016 was used. The Autoregressive Distributed Lag (ARDL) method was adopted to estimate the relationship between the variables. The study found that fiscal policy makers react to rising debt levels by adjusting primary balance by 0.087% when debt rises by 1%. Since this satisfies the intertemporal government budget constraint (IGBC) condition it was then concluded that the debt level of Ghana is sustainable. Government expenditure and its revenue cointegrate at 5% significance level and a unit increase in government revenue pushes government expenditure by 0.73%. Also the expenditures reaction to increase in revenues satisfies the Wald test restriction a1 = 1, implying that the solvency condition holds for Ghana. It is recommended to fiscal authorities to check primary fiscal balance through the business cycle in order to foster stable and higher economic growth while ensuring debt is also sustainable.

Dynamic Scoring: An Assessment of Fiscal Closing Assumptions

Analysis of fiscal policy changes using general equilibrium models with forward-looking agents typically requires the modeler to assume a counterfactual adjustment to some fiscal instrument in order to achieve the debt sustainability implied by the government's intertemporal budget constraint. Since the fiscal instrument chosen to close the model can induce economic behavior unrelated to the policy change in models where Ricardian Equivalence does not hold, noise may be introduced into the analysis. In this paper we use such an overlapping generations framework to examine the impact of alternative fiscal closing assumptions on projected changes to economic aggregates over the ten-year 'budget window' following a change in tax policy, assessing the extent to which the noise associated with a particular fiscal instrument can be mitigated. We find that while quantitative differences in projected macroeconomic activity can be observed across alternative fiscal instruments, these differences tend to shrink as the date that fiscal instruments begin to adjust is delayed into the future. Since the particular fiscal instrument chosen to achieve debt sustainability can then become relatively unimportant, the reliability of policy analysis obtained using this class of models may be improved.

Discounting the Deficit into Debt: The 3D Dilemma for the OECD Countries

Using annual data and both time series and a variety of panel econometric techniques for 22 OECD countries from the period of 1980-2016 we find that the euro countries as a group, and many of them as individual countries, too, are mainly dependent on their real economic performance regarding their possibilities to find a sustainable path for their public debt ratio. In our data the intertemporal government budget constraint (IGBC) does not seem to hold as a long-term equilibrium relationship, neither in the euro area nor in other OECD countries. However, as a shorter-term concept the a priori assumed relationship between the deficit ratio and the debt ratio might seem to hold especially for the part of OECD data, but there the real economic factors do not have almost any role in determining the debt ratio path. The differences in the dynamic relationships between the IGBC variables are very strong when comparing these two highly relevant economic areas of the global economy.

Analysing the Theoretical and Empirical Foundations of Public Debt Dynamics in Zimbabwe

This paper provides an analysis of the theoretical and empirical foundations of public debt dynamics in Zimbabwe. The analysis was undertaken by applying the debt dynamics equation that enables estimating the required primary balance, building on the government inter-temporal budget constraint to infer the factors that influence public debt, as well as to ascertain specific policy issues required to ensure a sustainable public debt structure. The results show that debt dynamics in Zimbabwe are largely composed of huge stock flow adjustments to finance social and political related expenditures. Results also indicate that the output gap had a significant influence on public debt dynamics in Zimbabwe. As such, the results underscore the need for prudent debt management to guard against unexpected changes in public debt, which are not explained by fundamentals. The major policy implication from the study is the need to minimize the interest rate growth differential and to implement growth enhancing fiscal policies to ensure a sustainable long term public debt position.

The fiscal gap: An estimate for Russia

Abstract The fiscal gap is an indicator of the long-term balance of public finance and is calculated based on the intertemporal government budget constraint, which links government tax revenues and expenditures over long intervals. The estimate of the fiscal gap for the Russian general government has been determined according to three scenarios with varying assumptions regarding demographic trends, productivity growth rates, oil and gas prices and the quantity of extractable reserves. The calculations show that the current fiscal policy cannot provide for the stability of public finance in the long run. The main factors of budget imbalances are the growth of pension and health care expenditures caused by demographic trends and the gradual decline in tax receipts from the oil and gas sector.

Public Debt, Productive Public Spending and Endogenous Growth

We analyse the effects of public debt in a basic endogenous growth model with productive public spending. We demonstrate that a discretionary policy in general violates the intertemporal government budget constraint along a balanced growth path. A balanced government budget gives a unique saddle point stable growth path. With a rule-based policy, two saddle point stable balanced growth paths can occur, depending on the intertemporal elasticity of substitution of consumption and on the primary surplus policy. Higher debt goes along with smaller long-run growth and we derive a condition such that a deficit-financed increase in public spending raises the growth rate.

Effects of fiscal policy on private consumption: evidence from structural-balance fiscal rule deviations

We use a new narrative measure of fiscal shocks to study how private consumption reacts to government spending increases. Our fiscal shocks arise from three announcements of expansionary fiscal rule deviations in a small and open economy where fiscal policy follows a structural-balance fiscal rule. All those deviations were announced to be mainly on the spending side. We find a negative response of private consumption in the face of those announcements. Our findings are consistent with the existence of consumers expecting some irreversibility in government spending increases and, as a consequence, a rise in future taxes to make the newly announced fiscal spending path consistent with the intertemporal government budget constraint.

Intertemporal Budget Policies and Macroeconomic Adjustment in Indebted Open Economies

AbstractThis paper analyzes the role of government intertemporal budget policies in a growing open economy including nominal assets in the presence of an upward sloping supply of debt. This introduces transitional dynamics that influence the effects of government policy instruments on economic growth and the long term fiscal liability. It is shown that capital income taxes or a combination of tax‐cum‐expenditure or government expenditure alone can balance the long term intertemporal government budget constraint. However, those results are shown to depend critically upon the extent of distortion in capital flows brought about the upward sloping supply of debt.