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Assessing the Sustainability of Government Debt: On the Different States of the Debt/GDP Process

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  • Anton Velinov
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    Abstract

    This paper discusses the type of trajectory a country's public debt path follows. In particular, a Markov switching ADF model is used to assess the sustainability of public debt by testing whether a government's present value borrowing constraint holds. Building on the work of Raybaudi et al. (2004) and Chen (2011), the model in this paper generalizes their methodology. The number of lags and states are in principle unrestricted and all of the parameters can be switching. Debt trajectories of 16 countries are investigated using long time series on debt/GDP obtained from Reinhart and Rogoff (2011). Two different criteria are used to test the null hypothesis of a unit root in each state. The countries with a sustainable debt path are found to be Finland, Norway, Sweden, Switzerland and the UK, while Greece and Japan are found to have unsustainable debt trajectories. The debt paths of the remaining countries are mainly characterized as being in a unit root state and are therefore labeled as uncertain. Robustness tests indicate that the model is robust to the sample size and the number of states used. Further, it is shown that the models used in this paper offer an improvement to existing models investigating this subject.

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    File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.436219.de/dp1359.pdf
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    Bibliographic Info

    Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1359.

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    Length: 35 p.
    Date of creation: 2014
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    Handle: RePEc:diw:diwwpp:dp1359

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    Keywords: Markov switching; debt trajectory; debt sustainability; unit root;

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    16. David W. Wilcox, 1987. "The substainability of government deficits: implications of the present- value borrowing constraint," Working Paper Series / Economic Activity Section, Board of Governors of the Federal Reserve System (U.S.) 77, Board of Governors of the Federal Reserve System (U.S.).
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    18. Gabriel, Vasco J. & Psaradakis, Zacharias & Sola, Martin, 2002. "A simple method of testing for cointegration subject to multiple regime changes," Economics Letters, Elsevier, Elsevier, vol. 76(2), pages 213-221, July.
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