A new test for fiscal sustainability with endogenous sovereign bond yields: Evidence for EU economies

Joanna Mackiewicz-Łyziak and Tomasz Łyziak

Economic Modelling, 2019, vol. 82, issue C, 136-151

Abstract: In this paper we develop a new test for fiscal sustainability and propose a synthetic fiscal sustainability indicator. Conventional tests based on fiscal reaction functions assume a constant real interest rate. However, many empirical studies find evidence on a positive response of long-term rates to sovereign debt levels. We take this evidence into account and endogenize the long-term real interest rate in testing fiscal sustainability. We apply the new test for the European economies. We find that considering the response of interest rate to debt may change the assessment of fiscal sustainability. More specifically, our results indicate that fiscal sustainability is at risk in a number of European Union economies, even if the results of traditional approaches suggest sustainable fiscal policy.

Keywords: Fiscal policy; Fiscal rules; Long-term bond yields; European Union (search for similar items in EconPapers)
JEL-codes: C54 E43 E62 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:82:y:2019:i:c:p:136-151

DOI: 10.1016/j.econmod.2019.01.001

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