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Analyzing the sustainability of fiscal deficitsin developing countries

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  • Cuddington, John T.

Abstract

The author surveys the recent literature on the sustainability of fiscal deficits, most of which focuses on the United States and other industrial countries, to see how useful it might be in developing countries. The accounting approach to analysis focuses on steady states and assumes that a fiscal deficit (or surplus) that leads to unchanging debt/GDP ratios over time is sustainable. The data required to apply this approach are relatively modest. The present-value constraint (PVC) approach assumes that the sustainability of fiscal policy depends ultimately on what level of fiscal deficit is financeable, which depends in turn on the behavior of lenders. Recent empirical implementations of this approach concentrate on methods for testing whether maintaining current fiscal policy (as captured by historical time series on government spending, revenue, and debt) violates the present-value-constraint or, equivalently, the no-Ponzi-game (NPG) condition. The econometric methods used in this literature (such as tests for the prsence of unit roots and cointegration) require long-time series over a constant fiscal regime, requirements that may be unrealistic in many countries. Typically, analyzing the sustainability of deficits in developing countries involves issues that are not particularly important in industrialized countries. Developing countries rely far more on seignorage to finance deficits, although the degree of that reliance varies greatly among countries; the simultaneous presence of both domestic and foreign-currency borrowing is central in a growing number of developing countries; and concessional lending and grants may also be an important part of fiscal finance. The author generalizes the PVC approach to economies that use money-financing of deficits, economies for which concessional financing is available, and economies that incur both domestic and foreign debt. He proposes a possible compromise in approaches: rather than use time series techniques to describe constant fiscal regimes, one can specify fiscal rules into the foreseeable future based on country-specific information about fiscal targets (perhaps as stated in IMF stabilization programs). Then one can calculate the implied time path for domestic and foreign debt, given current debt levels as initial conditions. Using this hypothesized time path for debt, one can ask whether it satisfies the no-Ponzi-game condition. If it does, fiscal policy is -by this definition- sustainable. If the NPG condition is violated, fiscal policy is unsustainable.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1784.

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Date of creation: 30 Jun 1997
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Handle: RePEc:wbk:wbrwps:1784

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Keywords: Economic Theory&Research; Environmental Economics&Policies; Payment Systems&Infrastructure; Banks&Banking Reform; Strategic Debt Management; Economic Theory&Research; Economic Stabilization; Banks&Banking Reform; Strategic Debt Management; Environmental Economics&Policies;

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Cited by:
  1. Cassimon, Denis & Moreno-Dodson, Blanca & Wodon, Quentin, 2008. "Debt Sustainability for Low-Income Countries: A Review of Standard and Alternative Concepts," MPRA Paper 11077, University Library of Munich, Germany.
  2. Gunter, Bernhard & Wodon, Quentin, 2008. "Analyzing Debt Sustainability: An Application of SimSIP Debt for Paraguay," MPRA Paper 11076, University Library of Munich, Germany.
  3. António Afonso, 2000. "Fiscal policy sustainability: some unpleasant European evidence," Working Papers Department of Economics, ISEG - School of Economics and Management, Department of Economics, University of Lisbon 2000/12, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  4. Marco Arnone & Luca Bandiera & Andrea Presbitero, 2005. "External Debt Sustainability: Theory and Empirical Evidence," International Finance, EconWPA 0512007, EconWPA.
  5. Antonio Afonso, 2004. "Fiscal Sustainability: the Unpleasant European Case," Money Macro and Finance (MMF) Research Group Conference 2004, Money Macro and Finance Research Group 57, Money Macro and Finance Research Group.
  6. M. Arnone & A. F. Presbitero, 2007. "External Debt Sustainability and Domestic Debt in Heavily Indebted Poor Countries," Rivista Internazionale di Scienze Sociali, Vita e Pensiero, Pubblicazioni dell'Universita' Cattolica del Sacro Cuore, vol. 115(2), pages 187-213.
  7. Sène, Babacar, 2004. "Impact du fardeau virtuel de la dette sur le taux de change réel d’équilibre des pays en développement : un modèle théorique," Economics Papers from University Paris Dauphine, Paris Dauphine University 123456789/6259, Paris Dauphine University.
  8. Annalisa Fedelino & Alina Kudina, 2003. "Fiscal Sustainability in African HIPC Countries," IMF Working Papers, International Monetary Fund 03/187, International Monetary Fund.
  9. Pablo Mendieta Ossio & Hugo Rodriguez Gonzales, 2005. "Interacción de la política fiscal con la política monetaria en el MERCOSUR y países asociados," Revista de Análisis del BCB, Banco Central de Bolivia, Banco Central de Bolivia, vol. 8(1), pages 49-97, December.
  10. Carrera, Claudia Martínez & Vergara, Rodrigo, 2012. "Fiscal Sustainability: The Impact of Real Exchange Rate Shocks on Debt Valuation, Interest Rates and GDP Growth," World Development, Elsevier, Elsevier, vol. 40(9), pages 1762-1783.
  11. Polito, Vito & Wickens, Mike, 2012. "A model-based indicator of the fiscal stance," European Economic Review, Elsevier, Elsevier, vol. 56(3), pages 526-551.

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