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Debt and Deficit Ceilings, and Sustainability of Fiscal Policies: An Intertemporal Analysis

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  • Uctum, Merih
  • Wickens, Michael

Abstract

In this paper, we examine the likely consequences for the sustainability of fiscal policy of pursuing goals that rely on restrictive ceilings on deficits and debt. We provide a formal theoretical framework for analyzing the sustainability of fiscal policy based on the government intertemporal budget constraint and derive conditions that determine whether a given fiscal stance is sustainable. This framework generalizes the existing literature in several important respects. We allow for time-varying interest rates, for the primary deficit to be endogenous, for a finite planning horizon suitable for medium-term policy making, for possible future policy shifts, we show how published forecasts can be used and we provide a measure of fiscal pressure. We then apply this analysis to the fiscal positions of the United States and the European Union countries since 1970 and to their planned positions over the next decade. We find that many countries do not have a sustainable policy. The evidence in favor of sustainability is strengthening for most countries when the data are extended to incorporate future fiscal consolidation plans, reflecting the general shift toward fiscal austerity in recent years. In contrast, with a finite horizon we show that the recent policy shift made the paths of future policies sustainable. However, imposing ceilings on debt or deficit-to-GDP ratio throws most economies onto an unsustainable path unless governments undertake a major tax or expenditure adjustment. High-debt countries can satisfy the 60 percent debt rule by 1999 only by raising (reducing) the average tax (spending) rate substantially for five years. A 3 percent plan 1999 or a zero-deficit plan by the year 2002, puts an increasingly high pressure on most economies, including the United States, requiring a gradual rise (decline) in the tax (spending) rate.

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Bibliographic Info

Article provided by Department of Economics, University of Oxford in its journal Oxford Bulletin of Economics & Statistics.

Volume (Year): 62 (2000)
Issue (Month): 2 (May)
Pages: 197-222

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Handle: RePEc:bla:obuest:v:62:y:2000:i:2:p:197-222

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  1. Buiter, W.H. & Corsetti, G. & Roubini, N., 1992. "Excessive Deficits: Sense and Nonsence in the Treaty of Maastricht," Papers 674, Yale - Economic Growth Center.
  2. Eisner, Robert & Pieper, Paul J, 1986. "A New View of the Federal Debt and Budget Deficits: Reply," American Economic Review, American Economic Association, vol. 76(5), pages 1156-57, December.
  3. Ball, Laurence & Elmendorf, Douglas W & Mankiw, N Gregory, 1998. "The Deficit Gamble," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 699-720, November.
  4. Bharat Trehan & Carl E. Walsh, 1987. "Common trends, the government's budget constraint, and revenue smoothing," Working Papers in Applied Economic Theory 87-11, Federal Reserve Bank of San Francisco.
  5. Wickens, M. R. & Uctum, Merih, 1993. "The sustainability of current account deficits : A test of the US intertemporal budget constraint," Journal of Economic Dynamics and Control, Elsevier, vol. 17(3), pages 423-441, May.
  6. Lars Peter Hansen & Thomas J. Sargent, 1979. "Formulating and estimating dynamic linear rational expectations models," Working Papers 127, Federal Reserve Bank of Minneapolis.
  7. Smith, Gregor W & Zin, Stanley E, 1991. "Persistent Deficits and the Market Value of Government Debt," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(1), pages 31-44, Jan.-Marc.
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