Intertemporal Budget Constraint Research Articles

Assessing Fiscal Sustainability with Panel Unit Root, Cointegration, and Granger Causality Tests: Evidence from the Broader Groups of Countries

Abstract The question of fiscal sustainability of countries has become one of the central topics in economic policy, especially in times of increasing public debts. One way to assess fiscal sustainability is to examine compliance with the intertemporal budget constraint, which involves testing the stationarity of government revenues and expenditures, the primary budget balance, and the first differences of public debt. Part of this approach includes testing cointegration and causality among different pairs of variables. Under this approach, the paper is focused on both first- and second-generation panel unit root tests, cointegration, and Granger causality test. This paper focuses on assessing the fiscal sustainability of four panels of countries divided by continents: Europe, Asia and Oceania, Africa, and Latin America, the Caribbean, and North America. It has been found that fiscal sustainability is present in all the broader groups of countries considered but in a weak form. Fiscal sustainability was confirmed when considering a constant in calculations, while deviations were observed among groups of countries when both a constant and trend were considered. The study serves as a starting point for a more extensive analysis of fiscal sustainability. For more accurate findings, it would be necessary to categorize countries into smaller and economically more homogeneous groups and analyze them using other fiscal sustainability methods as well.

The Fiscal Reaction Function and the Transmission Mechanism for Pakistan

Modern macroeconomics literature emphasises both the short run and long run objectives of fiscal policy [Romer (2006)]. In the short run it can be used to counter output cyclicality and/or stabilise volatility in macro variables, which is descriptively same as of effects of the short run monetary policy. Further for the long-run, fiscal policy can also affect both the demand and supply side of the economy. But in most traditional analyses it is assumed that fiscal policy would adjust to ensure the intertemporal budget constraint to be satisfied, while monetary policy is free to adjust its instruments [‘Ricardian Regime’ by Sargent (1982)] such as stock of money supply or the nominal interest rate [Walsh (2003)]. The debt financing methods, expenditure and tax powers of fiscal authorities i.e. the fiscal policy has also been seen as to affect both the supply and demand side of the economy. As noted by Baxter and King (1993), the initial Real Business Cycle models had only the supply side effects of the fiscal policy, where these were transmitted through the wealth effect and labourleisure choices of the household. Recently also New-Keynesian type models with micro-foundations and sticky prices argue that still through the supply side fiscal policy management could be accorded for stabilisation [Linnemann and Schabert (2003)]. The demand side effects of the fiscal policy could also be found only with more imperfections such as ‘Rule of Thumb’ consumers or those with liquidity constraints, which lead to exclusion of Ricardian equivalence [Gali, et al. (2005)]. But all that depends on the structure of the economy, as Blanchard and Perotti (2002) stated:

INTERTEMPORAL CONSUMPTION WITH ANTICIPATING, REMEMBERING, AND EXPERIENCING SELVES

AbstractWe study intertemporal choice through a novel and flexible framework that accounts for savoring of future consumption and memories of past consumption. The model uses standard intertemporal budget constraints but enriches preference structures with utility from anticipation, remembering, and experience. We also present an internal commitment mechanism that ensures dynamic consistency. We provide a revealed preference characterization of this model and apply it to quarterly consumption data from Spanish households. Utility from anticipation is important—and time inconsistency not strictly needed—to rationalize consumption patterns in the data.

Testing the Fiscal Theory of Price Level for Türkiye with Fourier-Based Empirical Approaches

Inflation is introduced as a monetary phenomenon in orthodox approaches. However, in the fiscal theory of the price level, the policies implemented by the fiscal authority, which determines the present value of intertemporal budget constraint independently of its liabilities, may be determinative of the price level. In this study, the validity of the fiscal theory of the price level for Türkiye was tested via the Fourier-ADL co-integration and Fourier Toda-Yamamoto causality approach. The findings indicate that fiscal policy was effective in determining the price level in the 1975-2021 period.

Empirical examination of public debt sustainability in African economies: A panel data analysis

This study intends to investigate public debt sustainability across 29 Sub‐Sahara African (SSA) economies, employing various econometric specifications, for the sampled years 1996–2020. The study employs Bohn's (Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint? Journal of monetary Economics, 54(7), pp.1837–1847.) framework of sustainability as the baseline model to assess public debt sustainability across the sampled Sub‐Sahara African economies. As additional tests of public debt sustainability in order to support the baseline findings, the study also employs panel unit root and timeseries unit tests. The baseline findings from the OLS, panel quantile and instrumental panel quantile regressions show that public debt is sustainable across the panel of SSA economies. The positive and statistically significant response of primary balance under the Bohn's framework of sustainability manifest that the intertemporal budget constraint is not violated in the sampled economies. The consistency in the estimates under the OLS, panel quantile and instrumental panel quantile regressions also show that the estimates are robust throughout the estimation process. Also, utilizing the panel unit root test for public debt sustainability, the findings show that public debt is stationary over the sampled years which implies that intertemporal budget constraint holds and that public debt is sustainable across the sampled SSA economies. However, the timeseries analysis indicate that although majority of the SSA economies have sustainable public debt ratios, four countries namely Uganda, Sudan, Togo and Cote d'Ivoire have unsustainable public debt ratios. The study has important policy implications in terms of prudent public debt management and fiscal management for the sampled SSA economies.

Intertemporal budget constraint and current account sustainability: Evidence from a large emerging economy

This paper examines the sustainability of the current account deficit (CAD) and validity of the intertemporal budget constraint of India for the period of 1980 to 2019. The cointegration results show that exports and imports are not cointegrated and the current account (CA) series is not mean reverting during the study period. Therefore, the results refute the sustainability of CAD and the validity of the intertemporal budget constraint in the Indian context. Furthermore, the study also emphasised the testing of the disaggregated CA and found that while the goods account is not sustainable, the services account found to be sustainable in the long run. Our findings thus indicate the potential for aggregation bias to have an impact on the overall CA sustainability results. Therefore, policies that help in achieving self‐sufficiency on the one hand and export promotion in goods on the other may eventually contribute to CA sustainability.

Testing Fiscal Sustainability in Bosnia And Herzegovina

Considering contemporary economic trends and the importance of fiscal policy instruments for ensuring macroeconomic stability, the research focuses on fiscal sustainability. Accordingly, special attention is paid to the empirical approach to fiscal sustainability, where the central question in considering the long-term sustainability of public finances is the concept of intertemporal budget constraint. The potential cointegrating relationships between public revenues and public expenditures, which represent the basic condition for fiscal sustainability, were tested on the example of Bosnia and Herzegovina. Testing the cointegration of time series was performed using the Engle-Granger two-step procedure and then using the Johansen procedure based on the VAR model. Finally, based on the above, the results of the fiscal sustainability analysis of Bosnia and Herzegovina were summarized, which are relevant for defining macro-fiscal goals and development-oriented policies.

The sustainability of current account in the BRICS countries depends on economic policies’ support to structural adaptation

This study undertakes a descriptively comprehensive and statistically robust assessment of the sustainability of current account (CA) and solvency of intertemporal budget constraint (IBC) in the BRICS countries. The long-run model estimated in one-regime setting with no structural break and in sample-split setting with multiple structural breaks provides dominant support to the sustainability of CA and solvency of IBC. The policy makers in the countries with surpluses in CA, such as China and Russia, need to manage upward pressure on domestic currency, encourage domestic investment, and seek opportunities for outward FDI. The central bank interventions in FOREX market, accompanied by both short-term portfolio and long-term direct investments overseas, would help relieve upward pressure on domestic currency and make productive use of foreign exchange reserves. The policy focus in the countries with deficits in CA, such as Brazil, India and South Africa, should be to accelerate productivity, boost exports, bolster saving, and implement fiscal consolidation to ensure the sustainability of CA and solvency of IBC.

Assessing the sustainability of fiscal policy in Morocco: Insights into economic stability

This study explores the sustainability of fiscal policy in Morocco, a country with limited natural resources, by examining the factors that contribute to its long-term effectiveness. To assess fiscal policy sustainability, we used a quantitative approach, drawing on historical data and relevant macroeconomic indicators. Our analysis focused on the relationship between fiscal policy and economic growth, which is a crucial factor affecting public finance sustainability, among other key macroeconomic indicators. We utilized a combination of two models, cointegration strategy and Bohn's adapted specification method, to investigate the long-run properties of the intertemporal budget constraint. Our findings suggest that fiscal policy in Morocco may not be sustainable and effective in the long-term, indicating potential risks and threats to the country's economic stability. Unsustainable fiscal policies can lead to a lack of confidence in public finance, currency depreciation, and inflationary pressures. Therefore, it is essential to take action to address the sustainability of Morocco's fiscal policy to counteract potential crisis shocks on the economy. The research suggests policymakers the need to implement effective fiscal policy that can address the challenges facing Morocco's economy. The fiscal rules will confronting the economic structural problems; however, it will promoting fiscal transparency and long-term economic growth.

Fiscal Sustainability in Focus

As regards the concept of fiscal sustainability, our study finds that in this area a variety of issues can be examined with very different tools. The issues may concern the achievement of fiscal constraints over an infinite horizon, the realisation of a specific target, or the fiscal policy response to indebtedness observed in the past. In some cases additional aspects of sustainability are considered too, such as the effects of ageing, although the consequences of rising inequality are mostly overlooked. The model may also include an estimate of the investment needed to mitigate the effects of climate change, but the impact of the impact of climate change is outside the model framework. To answer these questions, it may also be necessary to include uncertainty, in which case the discounting of future debt, tax revenue and expenditure with an intertemporal budget constraint in a stochastic environment depends on the probability distribution of these factors under different states. Our sustainability analysis, on the one hand, presents the best practice, complemented with the directions we have identified for further improvement. On the other hand, we have made the necessary corrections to avoid oversimplification in calculating debt dynamics.

Fiscal sustainability under a paper standard: two paradigms

This paper investigates the theoretical foundations of fiscal sustainability and the policy prescription that when the trajectory of public debt is above a certain threshold, priority should be given to fiscal consolidation. The author contends that the assumption that the government sector is subject to an intertemporal budget constraint can be validated only within a real-exchange economy where money is neutral and public debt entails the absorption of private savings. Conversely, when the economy is viewed as a system of interlocking balance sheets under a paper standard, public debt may prompt higher prices but not an inflation overhang forcing monetization or default. Another justification regards the quality of spending when policymakers’ incentives create a deficit bias, but this must be balanced against the need to flexibly provide safe financial assets to offer fiscal support when needed. In conclusion, limiting fiscal action within an intertemporal budget constraint is unwarranted under a paper standard and generates deflationary effects, underlining the urgent need that Europe move decisively toward the creation of a coordinated fiscal policy joined to a permanent capacity to issue EU debt. This is today’s most urgently needed reform for the economic, social, and political sustainability of the European Union.

Testing fiscal sustainability in OECD countries: new evidence from the past centuries

ABSTRACT Using three complementary approaches that examine the fulfilment of the intertemporal budget constraint while avoiding explosive behaviour, this study examines the stationarity and the sustainability of public finance for six industrial countries over the period spanning from 1870 to 2017. According to Fourier DF unit root tests, time-varying fiscal reaction functions and threshold reaction functions, we find that longer-run debt sustainability is not rejected for the UK, Sweden, and for the US. The evidence is somewhat equivocal for Canada, Italy and Portugal.

Assessing the Long-Run Sustainability of Public Debt and Fiscal Deficit in India

This article assesses the long-run sustainability of public debt and fiscal deficit in India for the period 1980–1981 to 2019–2020. The study estimated a model-based fiscal reaction function (FRF) using the Autoregressive Distributed Lag (ARDL) model to assess debt sustainability. The results revealed that the primary surplus responds positively and significantly to the previous period debt in both the short- and long-run. This implies that the fiscal policy satisfies the intertemporal budget constraint (IBC) and follows the debt-stabilizing rule. Next, to assess the sustainability of the fiscal deficit, we examined the long-run association between total revenues and total expenditures using a structural break cointegration test. The results revealed that they are cointegrated, implying that IBC is met and the fiscal deficit is sustainable. The results of long-run estimation provide evidence in support of strong budgetary sustainability. Overall, the results indicate that the public debt and the fiscal deficit are sustainable in India. From a policy standpoint, our research suggests that the government should take the necessary measures to reduce the growing public debt to ensure its long-run sustainability.

Budget Deficit Sustainability: An Application to Turkey

In this study, sustainability of budget deficits in Turkey is examined empirically for the pe- riod from January 2006 to September 2020, using time series techniques based on monthly data, under the intertemporal budget constraint approach. In the analysis phase, the Johansen cointegration method was used for the long-term relationship of the series. Analysis results indicated that income and expenditure series are not cointegrated. It is concluded that budget policies for the period under consideration in Turkey are unsustainable; therefore, the applied fiscal policies should be reviewed.

Application of the Techniques of Determinants to Utility Maximization for a 4-Period Age-Specific Inter-Temporal Budget Constraints

The Lagrange multiplier (LM) method was used to derive a mathematical formulation to work out an optimal solution for a 4-period overlapping generation model with autonomous consumption to maximize a lifetime utility for households subject to age-specific inter-temporal budget constraints. In this paper, the use of Cramer’s rule is exhibited in finding the critical point where utility is maximized and to further test for sufficient conditions using the Hessian determinants to check if there is a local maximum in the critical point C utility is maximized. The use of the inter-temporal marginal rate of substitution was implored to show the future growth path of utility maximization an analytical argument was used to support such finding.

Public Debt Sustainability and the COVID Pandemic: The Case of Poland

Abstract This paper aims to analyse and assess the impact of the COVID pandemic effect on the public debt sustainability level in Poland. We put the following research hypothesis in our study: the pandemic period disallowed the production of primary fiscal surpluses and increased the level of fiscal unsustainability in Poland. We took the data from Eurostat and the European Commission databases. We used the Primary gap indicator and no-Ponzi condition as the research methods (for the short-term and the long-term analyses, respectively). Both methods derive from the theory of the intertemporal budget constraint. The results of the empirical studies did not allow us to reject the research hypothesis.

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.

Aggregate consumption and wealth in the long run: The impact of financial liberalization

SummaryThis paper investigates the impact of financial liberalization on the relationship between consumption and total wealth (i.e., the sum of asset wealth and human wealth). Financial liberalization is persistent and may signal changes in expected future consumption growth rates and/or in rates of return on wealth that, through the intertemporal budget constraint, affect the current consumption–wealth ratio. We estimate the long‐run relationship between consumption, total wealth, and financial liberalization by state space methods using quarterly US data. The results show that the trend in the consumption–wealth ratio is well‐captured by our baseline liberalization indicator. We find that the increase in this indicator over the sample period has increased the consumption–wealth ratio with about 10%. Investigating the responsible channel, additional estimates show that financial liberalization has predictive power for aggregate consumption growth rather than for returns, a result that supports an incomplete markets interpretation of the link between liberalization and the consumption–wealth ratio.

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.

Macroeconomic Disasters and Forward-Looking Consumers: Historical Evidence and Evidence from the COVID-19 Pandemic

Macroeconomic disasters (wars, pandemics, depressions) are characterized by drastic shifts and increased volatility of the aggregate consumption to income ratio. By standard intertemporal budget constraint logic, this ratio is linked to expectations of future income and consumption growth rates. We investigate whether these expectations suffice to explain the shifts in the consumption-income ratio that occur during disaster periods or whether, on the other hand, consumers become more forward-looking and therefore give more weight to these expectations during disaster times. Our theoretical framework implies that the predictive ability of the current consumption-income ratio for future income and consumption growth rates is higher during disaster episodes. We check this both for past disasters and the current COVID-19 pandemic through the estimation of panel data regressions for industrial economies using historical annual data (1870 - 2015) and recent quarterly data (1995Q1 - 2020Q4). Our estimations confirm that macroeconomic disasters, contrary to ordinary recessions, make consumers more forward-looking.