Sustainability of public debt,public capital formation,and endogenous growth in an overlapping generations setting

Under the golden rule of public finance for public investment with a constant budget deficit/GDP ratio, we show that for the sustainability of government budget deficits there is a threshold of the initial public debt for a given stock of public capital, and that this threshold level of public debt is increasing in the stock of public capital. If the initial public debt is greater than the threshold, the government can no longer sustain budget deficits, while if it is smaller, the government can conduct a permanent deficit policy, which eventually leads to a positive public debt/GDP ratio.     

THE BEHAVIOR OF U.S. PUBLIC DEBT AND DEFICITS DURING THE GLOBAL FINANCIAL CRISIS

In this paper we test the sustainability of U.S. public debt for the period 1916–2012 by analyzing how the primary surplus to gross domestic product (GDP) responds to changes in the debt to GDP ratio in a time‐varying parameter model. Further, we determine the stationarity property of the debt/GDP ratio while accommodating possible breaks in the data caused by wars and economic crisis under both the null and alternative hypotheses of an endogenous unit root test. The results show that the U.S. public debt was sustainable until 2005 when the primary surplus to GDP reacted negatively to the debt/income ratio. This is further exacerbated during the global financial crisis when primary surpluses continued to fall with increased debt, thus jeopardizing the sustainability of fiscal policy. While the stationarity test shows that the U.S. fiscal debt/GDP ratio is sustainable, it fails to highlight the risk that its debt policy has been becoming unsustainable in recent years. (JEL H62, E62, C2)     

FISCAL SUSTAINABILITY OF JAPAN: A DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM APPROACH

The purpose of this paper is to investigate the fiscal sustainability of Japan by applying a dynamic stochastic general equilibrium model to the Japanese economy. By introducing intermediation costs into the model, we succeed in explaining the observed relationship between the interest and GDP growth rates, which is crucial in testing for sustainability. When the projected real growth rate is 2.5%, the average real interest rate becomes 2.57%, and the debt‐to‐GDP ratio gradually increases stochastically so that government debt is not sustainable. To recover sustainability, the primary surplus must be 0.2% of GDP.     

Twin Deficits in the European Countries

Public debt is a burden on future electors and taxpayers. In the absence of constitutional constraints, the incumbent government may show the cost of some public expenditures or tax reductions toward the future by financing them via new debt. However, according to the Ricardian theorem of public debt, the burden of debt is always anticipated via increased saving. If this theorem were true, a budget deficit would not affect the current account of the balance of payment. This paper analyzes the relationship between trade deficit and budget deficit. Using yearly data for the period between 1970 and 2010 in 33 European countries, we find evidence supporting the hypothesis that a chronic and robust budget deficit generates a trade deficit. The dynamic estimates show that a 1 % decrease in the government budget surplus/GDP ratio tends to deteriorate the current account/GDP ratio of 0.37 %, confirming previous studies with a different empirical basis. Dividing the sample period into two sub-periods (1970–1991 and 1992–2010), empirical findings show that current and past values of government budget influence trade balance in the first sub-period, whilst past values of government budget affect trade balance in the most recent years. Moreover, the estimated effect of government budget on current account balance is positive and equal to 0.48 and 0.30, respectively. For the high deficit countries, a long-run relationship between these variables has been found, showing that one percentage point increase in budget surplus/GDP ratio is associated with an improvement in the current account balance of roughly 0.15 percentage point. The estimated long-run government budget elasticity is negative and statistically significant, while the estimated speed of adjustment is equal to 0.33. Finally, Granger causality tests show mixed results.     

WHAT IT TAKES TO SOLVE THE U.S. GOVERNMENT DEFICIT PROBLEM

This paper uses a structural multi‐country macroeconometric model to estimate the size of the decrease in transfer payments (or tax expenditures) needed to stabilize the U.S. government debt/gross domestic product (GDP) ratio. It takes into account endogenous effects of changes in fiscal policy on the economy and in turn the effect of changes in the economy on the deficit. A base run is first obtained for the 2013:1–2022:4 period in which there are no major changes in U.S. fiscal policy. This results in an ever increasing debt/GDP ratio. Then transfer payments are decreased by an amount sufficient to stabilize the long‐run debt/GDP ratio. The results show that transfer payments need to be decreased by 2% of GDP from the base run, which over the 10 years is $3.2 trillion in 2005 dollars and $4.8 trillion in current dollars. The real output loss is 1.1% of baseline GDP. Monetary policy helps keep the loss down, but it is not powerful enough in the model to eliminate all of the loss. The estimates are robust to a base run with less inflation and to one with less expansion. (JEL E17)     

Estimating Non‐Keynesian Effects for Japan

Is a fiscal stimulus effective? This classical question has received significant research attention since the collapse of the global financial services firm Lehman Brothers. Although most studies agree on the existence of Keynesian multiplier effects, several studies also demonstrate the existence of non‐Keynesian effects. What explains this lack of consensus in the literature? In this paper, we aim to bridge the two views by estimating a near‐vector autoregressive system that includes interaction terms of fiscal instruments, and the debt‐to‐gross domestic product (GDP) or the primary‐deficit‐to‐GDP ratios. Moreover, to embed the dynamics of the debt‐to‐GDP ratio in the analysis, we explicitly incorporate the government budget constraint. By computing and comparing the impulse response functions, we find Keynesian effects when fiscal conditions are sound, and non‐Keynesian effects when the primary deficit is large.     

The Measurement of the Utilisation Efficiency of External Debt Funds and Its Influencing Factors

This paper uses stochastic frontier analysis to measure the utilisation efficiency of external debt funds, and identifies what factors actually influence the utilisation efficiency of external debt funds. Measurements show that in both developing and developed countries, the utilisation efficiency of external debt funds shows a downward trend; this downward trend is more obvious in developed countries. Empirical analysis found that the trade deficit rate, the trade openness, the ratio of fiscal revenue to gross domestic product (GDP), and the inflation rate have a significant negative effect on the utilisation efficiency of external debt funds. The ratio of money and quasi money (M2) to GDP, the ratio of the population aged 15–65 to total population, the ratio of industry value‐added to GDP, and the investment growth rate have a significant positive effect on the utilisation efficiency of external debt funds. Furthermore, under the condition of high ratio of the population aged 15–65 to total population, an increase in the ratio of the population aged 15–65 to total population will have a larger effect on improving the utilisation efficiency of external debt funds. Under the condition of high trade deficit rate, an increase in trade deficit rate will have a bigger effect on decreasing the utilisation efficiency of external debt funds.     

Debt Policy Rules in an Open Economy

In a small open economy model of endogenous growth with public capital accumulation, we examine the effects of a debt policy rule under which the government must reduce its debt–GDP ratio if it exceeds the criterion level. To sustain public debt at a finite level, the government should adjust public spending rather than the income tax rate. The long‐run debt–GDP ratio should be kept sufficiently low to avoid equilibrium indeterminacy. Under sustainability and determinacy, a tighter (looser) debt rule brings welfare gains when the world interest rate is relatively high (low).     

How big is the Chinese Government debt?

China’s public debt does not provide a meaningful guidance about the government’s overall debt burden, since it also has various forms of contingent liabilities such as shortfalls in the pension fund, debts of local government investment vehicles, and nonperforming loans of the state-owned commercial banks. However, there is no authoritative data on the government’s overall debt burden. In this paper, we try to put together a complete picture by piecing together information available, following a consistent framework. Our results suggest that the Chinese Government’s total debt could be already above 100% of GDP, in contrast to the public debt/GDP ratio of 15.5. Urgent reforms are needed in order to reduce fiscal risks, although risks of debt crisis look small in the short term, given sound balance sheet of the public sector. Local governments’ borrowing without hard budget constraint presents the greatest risk to sustainability of China’s fiscal system.     

Testing the sustainability of German fiscal policy: evidence for the period 1960–2003

In this paper we test whether German public debt has been sustainable by testing how the primary surplus to GDP ratio reacts to the debt to GDP ratio. We apply semi-parametric regressions with time depending coefficients. This test shows that the mean of the coefficient relevant for sustainability is significantly positive over the time period considered. However, there is a negative trend in that coefficient which seems to have ceased to decline only in the middle to late 1990s.     

PUBLIC DEBT AND PUBLIC INVESTMENT IN AN ENDOGENOUS GROWTH MODEL WITH REAL WAGE RIGIDITIES

We present an endogenous growth model with public capital, public debt and real wage rigidities due to labor market imperfections. Assuming that the primary surplus relative to gross domestic produce (GDP) is a positive function of the debt to GDP ratio, we study growth and employment effects of deficit‐financed public investment using simulations as well as how fiscal policy affects stability of the economy. Further, we contrast the growth rate and the unemployment rate in the deficit scenario with that of the balanced budget scenario. Finally, we compare our results with those obtained in case of flexible wages and full employment.     

A Note on the (Un)Pleasant Arithmetic of Fiscal Policy: The Case of Italian Public Debt

Using the simple arithmetic of government budget constraint, we perform an illustrative analysis on the Italian case, investigating the consequences on the main public finance aggregates of the adoption of a fiscal policy rule responding to past real debt/GDP ratio. Such a rule, firmly grounded in the economic analysis, would allow the reduction of Italy's outstanding stock of debt without requiring the strict adherence to the 3 per cent criterion for deficit/GDP ratio, as prescribed by SGP (Stability and Growth Pact). We perform a forecasting exercise under five alternative scenarios and analyse the details of a structural debt reduction strategy with alternative yearly step.     

Fiscal deficits and growth in developing countries

This paper examines the relation between fiscal deficits and growth for a panel of 45 developing countries. Based on a consistent treatment of the government budget constraint, it finds evidence of a threshold effect at a level of the deficit around 1.5% of GDP. While there appears to be a growth payoff to reducing deficits to this level, this effect disappears or reverses itself for further fiscal contraction. The magnitude of this payoff, but not its general character, necessarily depends on how changes in the deficit are financed (through changes in borrowing or seigniorage) and on how the change in the deficit is accommodated elsewhere in the budget. We also find evidence of interaction effects between deficits and debt stocks, with high debt stocks exacerbating the adverse consequences of high deficits.     

Human capital formation and public debt: growth and welfare effects of three different deficit policies

We analyze an endogenous growth model public educational spending. We show that the balanced budget policy and the policy with a slight deficit yield higher growth than a debt policy where public debt grows at the same rate as GDP, unless the government is a creditor. As concerns welfare, it can be demonstrated that a strong deficit policy yields lower welfare than a balanced budget and a slight deficit policy, unless initial debt ratios are low and the intertemporal elasticity of substitution is high. Finally, there may exist an inverted U-shaped relation between welfare and deficit-financed educational spending.     

Fiscal space on the eurozone periphery and the use of the (partially) balanced-budget multiplier: The case of Spain

This article adopts the “functional finance” approach to consider the utilization of expansive fiscal policies in the members of the European Monetary Union most affected by high unemployment. As they do not have their own monetary policy, fiscal deficits require the issuing of public debt without the support of the central bank. The authors consequently incorporate the notion of a (partially) balanced-budget expansion to achieve the desired stimulus in gross domestic product (GDP) with the least possible effect on public debt. Their proposal is only a sort of “imperfect” balanced-budget expansion: It is based on the idea that simultaneous increases in public revenue and expenditure can boost GDP, but without any pretension of keeping public deficit unchanged. Specifically, the authors use the case of Spain to show that a more expansive fiscal policy is desirable on economic grounds, and that only institutional constraints prevent it. They do it presenting two alternative scenarios for the coming years and analyzing their different impact on unemployment and fiscal sustainability. The first represents a firm commitment to budget consolidation, whereas the second is based on this “imperfect” application of the balanced budget multiplier. The main conclusion is that a more expansive fiscal policy is perfectly compatible with finance sustainability.     

OPTIMAL DEBT AND ENDOGENOUS GROWTH IN MODELS OF INTERNATIONAL FINANCE

The International Monetary Fund, the World Bank and the bond rating agencies did not anticipate the crises in Asia 1997–98 and in Argentina 2001 . With this statement in mind, we consider some multi-stage inter-temporal stochastic optimisation models in international finance that imply theoretically founded and empirically measurable Early Warning Signals. The mathematical technique is dynamic programming/stochastic optimal control (DP/SOC).
The variables of interest are the optimal foreign debt, consumption, capital and the growth rate of GDP. They are used as benchmarks of economic performance. By comparing the actual debt to the optimal debt we derive a measure of the sustainability of the debt and vulnerability to default problems. The two sources of uncertainty – the productivity of capital and the real interest rate on the foreign debt – are modeled as stochastic processes. Specific applications of the DP/SOC techniques are given for country defaults in Asia and Latin America, and the US current account deficits.     

The impact of high government debt on economic growth and its channels: An empirical investigation for the euro area

This paper investigates the average impact of government debt on per-capita GDP growth in twelve euro area countries over a period of about 40 years starting in 1970. It finds a non-linear impact of debt on growth with a turning point – beyond which the government debt-to-GDP ratio has a negative impact on long-term growth – at about 90–100% of GDP. Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70 to 80% of GDP. The channels through which government debt is found to have a non-linear impact on the economic growth rate are private saving, public investment and total factor productivity.     

Assessing the stochastic stability of public debt: the case of Austria

This paper characterizes the long-run distribution of Austrian public debt using a Markov chain model of the debt-GDP ratio and several key macroeconomic variables. We apply Bayesian techniques to estimate the transition probabilities of the model which allows to incorporate information from other countries. Based on the model, we argue that the historical record of Austrian fiscal policy is consistent with a stable long-run distribution of the debt-GDP ratio with an expected value close to the 60% threshold of the Maastricht treaty. Our results suggests that the strong increase in the debt-GDP ratio in the aftermath of the recent financial crisis should be seen as a transitory tail event rather than as a sign of long-run unsustainability. However, we also show that the existence of a stable long-run distribution depends on a continuing tendency of fiscal policy to “lean against debt” by reducing the primary deficit in face of rising debt. Finally we assess how exogenous shocks to the primary deficit and real GDP growth affect the model-implied distribution.     

Testing for fiscal sustainability: New evidence from the G-7 and some European countries

Whether or not a government deficit is sustainable has important implications for policy. If the debt of a nation is sustainable, then it implies that the government should have no incentive to default on its internal debt. In this article we examine whether or not the debt-GDP ratios of the G-7 and some European countries can be characterized by a unit root process with the non-linear trend and asymmetric adjustment. The econometric methodology allows us to determine whether the stationarity holds for the government's debt–GDP ratio after considering the non-linear trend. Among the main results, it is found that it is very likely that the debt–GDP ratios of Canada, Germany, the US and Italy are stationarity after taking account of the non-linear trend in the long run. Nevertheless, it is model-dependent for the debt–GDP ratios of these countries to be asymmetrically adjusted after taking the non-linear trend into consideration.     

How to assess debt sustainability? Some theory and empirical evidence for selected euro area countries

In this article we elaborate on the test proposed by Bohn (1998) that suggests to study whether the primary surplus relative to Gross Domestic Product (GDP) is a positive function of the public debt to GDP ratio in order to detect whether debt policies are sustainable. We argue that this should be complemented by additional tests for countries with rising debt to GDP ratios. We, then, apply that test to some countries of the euro area. In addition, we perform stationarity tests with respect to the real deficit inclusive of interest payments in order to gain additional insight. We conclude that there is empirical evidence that the chosen paths of fiscal policies are sustainable for the countries we consider, although there are country specific differences in debt policies.