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A Retrospective Approach on Government Response to Increasing Public Debt: Empirical Evidence for European Countries

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  • Stoian, Andreea

    () (Bucharest Academy of Economic Studies)

Abstract

Many researchers have been focused for decades on the issue of public debt considering its effect on fiscal sustainability in the long run. There is a recent body of research showing that the current financial crises will lead to a considerable increase of public debt in a number of advanced economies. Many European countries have confronted with large and increasing public debt stocks that overrated GDP. Considering that, the question on how government should address this problem arises. Theoretically speaking, governments should increase/decrease primary surplus/deficit, and the response should be immediate. The aim of this paper is to investigate government’s reaction to increasing public debt for European Union countries. Fiscal reaction function is employed on annual data spanned mostly on 1980.2012. Empirical evidence shows various results. In the case of Germany fiscal policy is pro-cyclical, but the results reveal no significant reaction of government to changes in public debt. For Belgium and Denmark the test shows a long run relationship between cyclically adjusted primary balance and public debt and error correction term indicates the existence of adjustment mechanism in the short term for assessing primary surplus. In the cases of Spain and France the response is opposite as expected and parameters point out on difficulties in achieving a cointegrated relation. For Greece and Italy test rejects any cointegration relationship and the use of fiscal rule reveals that government has difficulties in generating primary surplus. This conclusion is also valid in the case of Portugal and the UK. In the cases of Sweden and Ireland government has the ability to generate primary surplus larger than the required one that stabilizes public debt.

Suggested Citation

  • Stoian, Andreea, 2011. "A Retrospective Approach on Government Response to Increasing Public Debt: Empirical Evidence for European Countries," Working Papers 15/2011, Universidade Portucalense, Centro de Investigação em Gestão e Economia (CIGE).
  • Handle: RePEc:ris:cigewp:2011_015
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    References listed on IDEAS

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    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2014. "A Decade of Debt," Central Banking, Analysis, and Economic Policies Book Series,in: Miguel Fuentes D. & Claudio E. Raddatz & Carmen M. Reinhart (ed.), Capital Mobility and Monetary Policy, edition 1, volume 18, chapter 4, pages 97-135 Central Bank of Chile.
    2. Inman, Robert P, 1990. "Public Debts and Fiscal Politics: How to Decide?," American Economic Review, American Economic Association, vol. 80(2), pages 81-85, May.
    3. Gebhard Kirchgässner & Silika Prohl, 2008. "Sustainability of Swiss Fiscal Policy," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 144(I), pages 57-83, March.
    4. Meltzer, Allan H & Richard, Scott F, 1981. "A Rational Theory of the Size of Government," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 914-927, October.
    5. Ram, Rati, 1986. "Government Size and Economic Growth: A New Framework and Some Evidencefrom Cross-Section and Time-Series Data," American Economic Review, American Economic Association, vol. 76(1), pages 191-203, March.
    6. North, Douglass C & Wallis, John Joseph, 1982. "American Government Expenditures: A Historical Perspective," American Economic Review, American Economic Association, vol. 72(2), pages 336-340, May.
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    Cited by:

    1. Iulian Viorel BRAȘOVEANU & Laura OBREJA BRAŞOVEANU, 2012. "Fiscal Policy In European Union Countries – A Comparative Analysis Of Adjustment And Expansions Fiscal Policy Episodes," Journal of Knowledge Management, Economics and Information Technology, ScientificPapers.org, vol. 2(3), pages 1-3, June.

    More about this item

    Keywords

    public debt; fiscal policy; primary balance; fiscal reaction function; fiscal sustainability;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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