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Sustainability of Public Debt and Budget Deficit: Panel cointegration analysis for the European Union Member countries

In this study, we analyse the sustainability of fiscal policy of EU member countries within the panel cointegration and error-correction frameworks. Unlike the previous empirical papers in this area, we apply the test for panel cointegration between the primary budget deficit and the public debt defined in GDP ratios. Based on the cointegration test results, we conclude that the fiscal policy is consistent with the intertemporal budget constraint, i.e., it is sustainable in the panel of fifteen EU member countries over the period from 1970 to 2004. Hence, we show that the fiscal balance exhibits a significant structural change in the year 1992, when we apply the Banerjee and Carrion-i-Silvestre (2006) test for a structural break in the panel cointegration relationship. In a next step, we search for the politico-economic factors which explain the variation in the sustainable fiscal balance among the European countries. We evidence that the European fiscal rules have a significant positive effect on the improvement of the fiscal position of the governments of the EU member countries.

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Paper provided by Department of Economics, Johannes Kepler University Linz, Austria in its series Economics working papers with number 2006-10.

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Date of creation: Jul 2006
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Handle: RePEc:jku:econwp:2006_10
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