Solvency and sustainability of fiscal policies in the EU

Summary This paper focuses on the sustainability and solvency issues of the public sector. Tests for sustainability heavily rely on the time-series properties of the debt-to-GDP ratio, whereas solvency test focus on the deficit inclusive of interest payments. Sustainability and solvency tests are applied first on 8 ERM countries during the period 1970–1994. Subsequently, we concentrate on historical evidence (from 1870 onwards) for the Belgian central government. This long-term view allows for a more accurate time-series analysis. On the one hand, we find historical support for the hypothesis that high and persistent deficits for some periods can be consistent with the present-value budget constraint (solvency), provided that policies are changed eventually. On the other hand, the much stronger requirement of sustainability is not fulfilled since we do not find a tendency of the debt ratio to return to a constant long-run equilibrium level.Previous versions of this paper were written while F. Vanhorebeek was a research assistant at the Department of Economics, Catholic University of Leuven. We are grateful to W. Asma; G. de Bruyne, N. Demeester and two anonymous referees for their comments regarding the paper's methodology. We have also benefited from useful conversations with E. Buyst and P. Clement on the subject of this paper, as well as from their help in obtaining historical data. Remaining errors are ours. The opinions expressed here are solely those of the authors and should not be attributed to any other person affiliated with the Planning Bureau or the University.