Unsustainable Fiscal Policies Research Articles

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, 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.

Policy asymmetries and fiscal sustainability: evidence from Nigeria

PurposeThis study examines and compares different specifications of the fiscal policy rule in the fiscal sustainability analysis of Nigeria.Design/methodology/approachThis is methodologically achieved by estimating the baseline constant-parameter and Markov regime switching fiscal models. The asymmetric autoregressive distributed lag fiscal model is also employed to substantiate the differential responses of fiscal authorities to public debt.FindingsThe baseline constant-parameter fiscal model provides mixed results of sustainable and unsustainable fiscal policy. The inconclusiveness is adduced to instability in primary fiscal balance–public debt dynamics. This makes it necessary to capture regime switches in the fiscal policy rule. The Markov switching estimations show a protracted fiscal unsustainable regime that is inconsistent with the intertemporal budget constraint (IBC). The no-Ponzi game and debt stabilizing results of the Markov switching fiscal model further revealed that the transversality and debt stability conditions were not satisfied. Additional findings from the asymmetric autoregressive model estimation show that fiscal consolidation responses vary with contraction and expansion in output and spending, coupled with downturns and upturns in public debt dynamics in both the long and short run. These findings thus confirm the presence of asymmetries in the fiscal policy authorities' reactions to public debt. Further, additional evidences show the violation of the IBC which is exacerbated by the deleterious effect of the pro-cyclical fiscal policy response in boom on the improvement of the primary fiscal balance.Originality/valueThis study deviates from the extant literature by accommodating time variation, periodic switches and fiscal policy asymmetries in the fiscal sustainability analysis of Nigeria.

Debt and Financial Crises

Emerging market and developing economies have experienced recurrent episodes of rapid debt accumulation over the past fifty years. This paper examines the consequences of debt accumulation using a three-pronged approach: an event study of debt accumulation episodes in 100 emerging market and developing economies since 1970; a series of econometric models examining the linkages between debt and the probability of financial crises; and a set of case studies of rapid debt buildup that ended in crises. The paper reports four main results. First, episodes of debt accumulation are common, with more than 500 episodes occurring since 1970. Second, around half of these episodes were associated with financial crises which typically had worse economic outcomes than those without crises— after 8 years output per capita was typically 6-10 percent lower and investment 15-22 percent weaker in crisis episodes. Third, a rapid buildup of debt, whether public or private, increased the likelihood of a financial crisis, as did a larger share of short-term external debt, higher debt service, and lower reserves cover. Fourth, countries that experienced financial crises frequently employed combinations of unsustainable fiscal, monetary and financial sector policies, and often suffered from structural and institutional weaknesses.

A counterfactual analysis of regulatory changes in Hungary: Could the FX lending crisis have been avoided?

The main purpose of this paper is twofold. First, it aims to estimate the effect of the tightening of regulatory capital requirements on the real economy in periods of credit upswing. Second, it intends to show whether applying a counter-cyclical capital buffer measure as set down in the Basel III rules could have helped to reduce the pace of FX lending growth in Hungary, mitigating the buildup of vulnerabilities in the run-up to the global financial crisis. In order to answer these questions, we use a Vector Autoregression-based approach with the aim of understanding the impact of shocks to capital adequacy in the pre-crisis period. Our results suggest that although regulatory authorities could have slowed down the increase in lending temporarily, they would not have been able to avoid the upswing of FX lending by requiring counter-cyclical capital buffers even if such a tool had been available and even if they had reacted quickly to accelerating credit growth. Our results also suggest that a more pronounced tightening might have reduced FX lending substantially, but at the expense of real GDP growth. The reason is that unsustainable fiscal policy led to a trade-off between economic growth and the build-up of new vulnerabilities in the form of FX lending.

Capital Adequacy Regulations in Hungary: Did It Really Matter?

The main purpose of this paper is twofold. First, it aims to estimate the effect of the tightening of regulatory capital requirements on the real economy during a credit upswing. Second, it intends to show whether applying a counter-cyclical capital buffer measure, as per the Basel III rules, could have helped decelerate FX lending growth in Hungary, mitigating the build-up of vulnerabilities in the run-up to the global financial crisis. To answer these questions, we use a Vector Autoregression-based approach to understand how shocks affected to capital adequacy in the pre-crisis period. Our results suggest that regulatory authorities could have slowed the increase in lending temporarily. They would not, however, have been able to avoid the upswing in FX lending by requiring counter-cyclical capital buffers even if such a tool had been available and they had reacted quickly to accelerating credit growth. Our results also suggest that a more pronounced tightening might have reduced FX lending substantially, but at the expense of real GDP growth. The reason is that an unsustainable fiscal policy led to a trade-off between economic growth and the build-up of new vulnerabilities in the form of FX lending.

Unsustainable Fiscal Policy: Implications for Monetary Policy

Federal government debt held by the public reached 67.7 percent of gross domestic product in 2011 and trends point to large budget deficits for many years to come. In this essay, Renee Haltom and John Weinberg explore the implications for monetary policy if the United States ever approached its fiscal limit. In that scenario, the Federal Reserve might face pressure to produce inflation revenue. The authors conclude that the United States must avoid this scenario by placing fiscal policy on a more sustainable path.

The Fiscal Framework in a Currency Union: Lessons from a Comparison between the Euro Area and the Eastern Caribbean Currency Union

AbstractThis paper draws out lessons from the euro area (EA) that are transferable to the Eastern Caribbean Currency Union (ECCU) and other Caribbean economies with fixed exchange rates. Based on observations from both the EA and the ECCU, we present a new policy framework which is capable of imposing fiscal discipline, with the aim of avoiding the risk of unsustainable fiscal policies reappearing and of preventing monetary policy from being undermined by undisciplined national governments. In the ECCU case, we find that fiscal deficits are more a result of financial and trade imbalances than fiscal indiscipline per se. Consequently, constraints on overall debt, public and private, rather than direct limits on endogenous public deficits, appear to be the appropriate response.

Lessons from Thailand's Fiscal Policy

If rules of fiscal sustainability are observed, available fiscal space permits effective countercyclical fiscal programs. The importance of automatic fiscal stabilizers should not be underestimated. The discretionary impact of increased public spending and tax cuts can be amplified if implemented when consumer confidence investor sentiments are high. There is no evidence to support non-Keynesian effects of fiscal policy in Thailand. Unwarranted fears of unsustainable public debt and ultra-conservative fiscal policy has cost the country a lost opportunity for achieving high growth. After the military coups in 2006 and 2014, the Thai economy experienced the lowest economic growth among ASEAN countries. The budget spent on economic services was diverted into defense, increases in public sector's wages, and income transfer payments. The opportunistic political budget model predicts higher fiscal spending by incumbent democratic governments before an election to gain votes. In the case of Thailand, such spending comes after military coups, akin to a military business cycle spending.

Assessing Fiscal-Policy Sustainability: On the Different States of the Debt-to-GDP Process

This paper assesses fiscal-policy sustainability. A sufficient condition for this is that public debt is on a stationary trajectory. This is tested by means of a very general Markov-switching augmented Dickey-Fuller (MS-ADF) model, which expands and improves simpler existing models of this type, and produces more reliable results than conventional state-invariant unit-root tests. Long data series (in some cases with more than 200 observations) on the debt-to-GDP ratio are analyzed for 16 countries. Empirical results indicate that Finland, Norway, Sweden, Switzerland, and the UK have sustainable fiscal policies. Greece and Japan have unsustainable fiscal policies, which could lead to debt default unless appropriate measures are taken. The remaining countries are characterized as having uncertain debt policies, which governments could take as a warning to try to better balance their budgets. The results are found to be robust to variations in the specific time period investigated and the number of states used.

Was Spanish fiscal policy sustainable?

Was unsustainable fiscal policy one of the reasons for the recent crisis in Spain? This is tested by examining how the government’s primary surplus is reacting to the debt-GDP ratio. Using different models for the explanatory variables and the consideration of the correct detrending method led to the result that Spanish fiscal policy reacted to higher debt by increased surpluses, and thus was sustainable. To deal with structural breaks in the models, firstly, a dummy for the recent financial crisis was added. Secondly, a Kalman (J Basic Eng 82(1):35–45, 1960) filter model allowing for time-varying coefficients was estimated to cope with remaining breaks. The reaction of Spanish fiscal policy on debt was found to be decreasing over time. However, it was still significantly positive, showing sustainability.

How Governments Should Support the Adjustment of Competitiveness in the Euro Area – and How They Should Not

In addition to unsustainable fiscal policies, the weak competitiveness of southern European countries is contributing to the ongoing crisis in the euro area. However, wages and productivity are only one element of competitiveness and the value of competitive wages is hard to measure. Hard‐to‐identify non‐price competitiveness such as quality, innovation and technology of goods affects overall competitiveness too. Given the lack of information, the necessary level of wage adjustment needs to be negotiated on the market. Governments can support a market based adjustment of competitiveness by liberalising labour markets and by strengthening the business environment.

Medium Term Fiscal Policy Issues and Challenges in Australia

Robinson presents an overview of fiscal policy objectives and challenges in Australia. He notes that from the mid-Eighties to the late Nineties fiscal policy basically reflected the need to lower the external current account deficit. Avoiding public sector dissaving was supposed to require the avoidance of (cash) budget deficits. The public sector was to refrain from drawing, other than temporarily during a recession, on private sector saving. The budget was to be balanced, on average, over the course of the economic cycle. In the second half of the Nineties, this policy view gradually changed. Fiscal sustainability became the key concern, in view of the potential threat of unsustainable fiscal policies to external balance and market confidence. However, the rule calling for a balanced-budget over the business cycle was not modified. Public debt is considered both a threat to fiscal sustainability and inconsistent with intergenerational equity. Robinson notes that no distinction is made between borrowing for capital purposes and borrowing for current purposes and that this may contribute to the capital spending drought in Australia. Taking into account asset sales, in recent years the federal government has recorded negative capital investment. Robinson finally notes the changes in the budget deficit concept. While in 1999 cash accounting was replaced by accrual accounting, in 2001 the government reverted again to a cash accounting concept of the budget balance.

Stable and enforceable: a new fiscal framework for the Euro area

Since the great financial crash, the need for new fiscal rules to prevent unsustainable fiscal policies is universally recognised. In practice such rules, including those in the Stability and Growth Pact, have proved to be impossible to enforce. Thus, to avoid unsustainable fiscal policies reappearing, and to prevent monetary policy from being undermined by undisciplined governments, there is a need for a framework capable of imposing fiscal discipline. This paper considers an intertemporal assignment, where fiscal policy focuses on long-term objectives and monetary policy on short-term stabilisation. We argue for public sector debt targets as a practical way to achieve such a set up, and an excess debt protocol is constructed to give enforceable form to those targets. The ideas of “fiscal space” and optimal debt levels are used to provide a mechanism for identifying a stable region within which the debt targeting regime should operate. Making these factors explicit would both improve the credibility of planned fiscal policies and reduce risk premia on borrowing costs. We finally show how Europe’s competitiveness pact, and debt restructuring operations, can be used to maximise the available fiscal space.

Sustainability of Mena Public Debt and the Macroeconomic Implications of the Recent Global Financial Crisis

In the wake of the recent US financial crisis and after the accumulation of sizeable public debts, especially in the emerging MENA countries of Egypt, Jordan, Morocco, Tunisia, and Turkey, the financial distress of the public sector has become a major source of concern for policymakers in the region. Using time series econometric tests, and the Present Value Constraint model, this study examines the sustainability of MENA public debt. The empirical results point to strong sustainability of fiscal policies in Tunisia, weak sustainability in Egypt, mixed results for Morocco, and unsustainable debt and fiscal policies in Jordan and Turkey. It is argued that the acceleration of fiscal reforms in the latter group of MENA countries is urgently needed; otherwise, those countries may experience further increases in an already large public debt, and more pressure on exchange and interest rates, with further macroeconomic imbalances. It is also argued that the recent global financial crisis is expected to put further strains on Jordan’s debt sustainability given its limited fiscal space and high debt to GDP ratio.

Facing a Break Point in Global Inflation Transmission?

The paper addresses the issue of the co-movements of national inflation dynamics with a common factor of a global dynamic. Based on the previous work of Ciccarelli and Mojon (2005) on global inflation the authors look at the more recent development in particular after the outbreak of the global financial crisis in July 2007. As a working hypothesis they try to find out if there is already sufficient empirical evidence available in the data that the massive liquidity pumped into the global financial system by central banks around the world together with the massive fiscal deficit spending of governments to cushion the recession could lead in the medium-term to an inflationary shock. Such rare events occurred in the past five decades only three times. We test especially after updating the data from 2004 until 2008/2009 depending on the data availability if there are already indications that inflationary pressures are building-up refuting expectations of many experts that the current global recession will increase the pressures on the global prices towards a global deflation. The combination of a coordinated reflationary monetary policy together with the fiscal stimulus packages already setup by governments around the globe should according to the fiscal theory of the price level tend to increase the joint-impact of these monetary expansions by the central banks and the governments towards a strong and rapid turn-around in the global price dynamics. Using an approach first established by Corsetti and Roubini (1991) we test for fiscal sustainability of the fiscal deficit positions in the OECD member countries. Further more we look at the impacts unsustainable fiscal policies have on the common factor of global inflation. The key question following from this is that after setting this process of an acceleration of global inflation into motion it could be hard to get the Gini back into the bottle. The experience of stagflation in the late 1970s and early 1980 are a warning sign that reflationary policies could lead to a significant overshooting in the reflationary macroeconomic impulse created around the globe.

Fiscal policy and interest rates in Europe

The appetite for fiscal discipline has been steadily declining among most industrial countries. In the past, fiscal profligacy would have been punished by markets with higher interest rates and, in some cases, also exchange rate depreciation. However, in post-EMU Europe, exchange rate markets no longer discipline the fiscal behaviour of national governments. Perhaps more crucially, even the interest rate punishment to fiscal indiscipline is highly uncertain, with academic opinions being quite divided on this issue. This paper takes a close look at the link between fiscal policy and interest rates in the European context. The key finding is that an expansionary fiscal policy in one EMU member will have an effect both on its spreads and on the overall level of interest rates for the currency union as a whole, with the second effect, however, being quantitatively much more significant. This suggests that there are indeed substantial spillovers, through the interest rate channel, among fiscal policies of member countries. To limit countries’ incentive to run expansionary fiscal policies, a set of rules, like those embedded in the Stability and Growth Pact, is then needed. Some (weak) evidence is also found that after EMU, interest rate spillovers seem to be more significant for high debt countries with unsustainable fiscal policies, reflecting perhaps market concerns about a possible sovereign bail out or the impact of financial distress. There may be a case then for imposing tighter rules on high debt countries. — Riccardo Faini

Social Health Insurance - the Major Driver of Unsustainable Fiscal Policy?

During the next decades the populations of most developed countries will grow older as a result of the low level of birth rates since the 1970s and/or the continuously increasing life expectancy. We show within a Generational Accounting framework how unsustainable the public finances of France, Germany, Switzerland and the U.S. are, given their demographic developments. Thereby, our focus lies on social health insurance systems which are in addition affected by the medical-technical progress. Due to the cost-increasing effect of the medical-technical progress one can justifiably say that social health insurance schemes are the major drivers behind unsustainable fiscal policies.

An Assessment of Fiscal Sustainability in Romania

This article analyses Romanian fiscal policy during the 1990s with the main emphasis on the aspect of sustainability of the budget situation. First, the study presents the general development of Romania's economy during the transition period as background for the subsequent policy analysis. Second, the problems of quasi-fiscal subsidies and payment arrears which led to very large quasi-fiscal deficits are highlighted. In the next step, a macroeconomic model is introduced to assess the degree of fiscal sustainability starting with the inter-temporal government budget constraint. The overall deficit for the general government, including central and local governments as well as other institutions belonging to the non-financial public sector, is computed using official statistics. The research findings suggest that Romania has followed an unsustainable fiscal policy in the transition period, particularly up to 1996. In the first half of the 1990s the government financed the deficit partly through seignorage and tried to deal with immediate pressures, preventing social dissatisfaction but neglecting long-term targets. The situation has improved slightly in recent years, nevertheless, there is still much to be done in this area.

Fiscal sustainability in the wake of the economic crisis in Korea

The total amount of government debt was expected to rise sharply over the following several years in the wake of the Korean financial and economic crisis in 1997, raising concern about the sustainability of government deficits and fiscal consolidation. This paper provides an overview of Korea’s fiscal stance after the financial crisis and the policy implications for fiscal consolidation by assessing fiscal sustainability. Sustainability tests are carried out and show that Korean fiscal policy for the period 1970–1999 should be regarded as sustainable. Indicators of sustainability are also measured to that Korean fiscal policy for the period 1970–1996 is sustainable. However, both the primary and tax gap indicators with a sharp rise in the debt ratios are shown to be worsening since 1997 indicating increasingly possible unsustainable fiscal policies. It implies that the current primary deficit is too large and current taxes are too low to stabilize the debt ratio.