Fiscal sustainability vs. fiscal stability: tax and debt under entitlement spending

Floriana Cerniglia - Enzo Dia - Andrew Hughes Hallett
Authors registered in the RePEc Author Service: Enzo Dia and Andrew Hughes Hallett

No crn1801, CRANEC - Working Papers del Centro di Ricerche in Analisi economica e sviluppo economico internazionale from Università Cattolica del Sacro Cuore, Centro di Ricerche in Analisi economica e sviluppo economico internazionale (CRANEC)

Abstract: Economists have traditionally used a rule that restricts primary deficits to less than a threshold determined by the interest-growth rate differential and existing debt in order to judge fiscal sustainability. This rule derives from a single period application of the government’s budget constraint. It is not forward looking. It does not allow for the predictable dynamics of spending liabilities, such as entitlement spending, and assumes immediate and infinitely elastic tax or spending adjustments that are unlikely to be feasible in practice. To address this issue, we derive the equivalent dynamic rule: the primary surplus needs to match any expected discounted increases in public spending, the net interest on existing debt, and terms reflecting the cost of extending debt relative to changing taxes. We find strong and robust empirical evidence supporting the model and we calibrate our model to analyze the impact of shocks to future sustainability (as opposed to current stability, a crucial distinctio n) in different countries.

Keywords: Sustainable public debt; primary deficit rules; fiscal space (search for similar items in EconPapers)
JEL-codes: E62 H53 H63 I38 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-mac and nep-pbe
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