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Fiscal Policy Sustainability, Economic Cycle and Financial Crises: The Case of the GIPS

  • Gabriella Legrenzi

    (Keele University, UK; CESifo, Germany; The Rimini Centre for Economic Analysis (RCEA), Italy)

  • Costas Milas

    (Liverpool University, UK; The Rimini Centre for Economic Analysis (RCEA), Italy;, Greece)

We extend previous work on the sustainability of the government's intertemporal budget constraint by allowing for non-linear adjustment of the fiscal variables, conditional on (i) the sign of budgetary disequilibria and (ii) the phase of the economic cycle. Further, our endogenously estimated threshold for the non-linear adjustment is not fixed; instead it is allowed to vary over time and during financial crises. Our analysis presents particular interest within the current economic scenario of financial crises, poor growth and debt crises. Our empirical analysis, applied to the GIPS, shows evidence of a threshold behaviour for the GIPS, that only correct "large" unbalances, which, in the case of Greece and Portugal, are higher than the EGSP criteria. Financial crises further relax the threshold for adjustment: during financial crises, only "very large" budgetary unbalances are corrected.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 54_12.

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Date of creation: Jul 2012
Date of revision:
Handle: RePEc:rim:rimwps:54_12
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