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Financial Crisis and Sustainability of US Fiscal Deficit: Indicators or Tests?

Paolo Canofari (), Giancarlo Marini and Alessandro Piergallini ()

Journal of Policy Modeling, 2020, vol. 42, issue 1, 192-204

Abstract: Whether or not budgetary policies are sustainable and can be conducted without creating the potential for government bankruptcy is a central question for macroeconomic analysis. In this paper, we show that indicators and tests to assess government solvency should not be used alternatively. We lay out a simple and intuitive procedure to integrate simultaneously the results from the two approaches to fiscal sustainability. Indicators are forward looking, for they are based on published forecasts, thus reacting to a set of current and expected future conditions in fiscal-policy making. Tests, by contrast, are backward looking, for they are based on a sample of past data. In the event of conflicting results, indicators may signal the occurrence of a structural change in policy, which may reverse the predictions of tests. Whether the results from indicators or from tests should be given priority in the assessment of the sustainability of public debt will thus depend on the structural stability of the historical data generating process of the primary surplus. Only in the absence of a structural break in the stance of fiscal policy, the potential warning predictions of fiscal indicators should be interpreted as merely reflecting transitory factors to be eventually reversed. An application to U.S. post-World War II historical data, from 1948 to 2016, and forecasts, from 2017 to 2027, demonstrates the empirical relevance of the proposed comprehensive approach and helps add new insights to the evaluation of the U.S. fiscal position. In particular, our results suggest that the potentially unsustainable course of U.S. fiscal policy from 2008 onwards, advocated by the use of fiscal indicators, reflects systematic—not cyclical—factors. The main policy implication is that deficit increases in the U.S. from 2008 onwards cannot be regarded as a transitory phenomenon and hence do entail an urgent need for a structural change in the future stance of budgetary policy.

Keywords: Fiscal sustainability; Fiscal indicators; Tests of government solvency; Structural change (search for similar items in EconPapers)
JEL-codes: C12 C22 E60 H60 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jpolmod.2019.09.004

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