Deficit sustainability and fiscal theory of price level: the case of Italy, 1861–2020

Emilio Congregado, Carmen Diaz-Roldan and Vicente Esteve ()
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Vicente Esteve: Universidad de Valencia

Empirica, 2023, vol. 50, issue 3, No 6, 755-782

Abstract: Abstract We test sustainability of the Italian government deficit over the period 1861–2020 using the fiscal theory of the price level (FTPL). This approach takes into account monetary and fiscal policy interactions and assumes that fiscal policy may determine the price level even if monetary authorities pursue an inflation-targeting strategy. We consider a cointegrated model with multiple structural changes to characterize the sustainability of public finances and the prevalence of monetary or fiscal dominance during subperiods. We also use recursive unit root tests for explosiveness to test fiscal sustainability and to detect episodes of potential explosive behaviour in Italian public debt. We find two structural changes for the public debt and one change in the primary budget surplus, the alternation of monetary and fiscal dominant regimes, as well as evidence of bubbles related to three episodes of the Italian fiscal performance. Our results reveal the sensitiveness of the primary balance and the debt paths to shocks hitting fiscal, macroeconomic, and financial variables.

Keywords: Fiscal theory of the price level; Monetary and fiscal dominance; Fiscal sustainability; Inflation; Public debt; Explosiveness; Cointegration; Multiple structural breaks (search for similar items in EconPapers)
JEL-codes: E62 H62 O52 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s10663-023-09577-w

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