What is fiscal sustainability?―Transversality condition, Domar condition, the fiscal theory of the price level―

Masataka Eguchi and Toshiya Hatano
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Masataka Eguchi: Associate Professor, Faculty of Economics, Komazawa University

Public Policy Review, 2023, vol. 19, issue 3, 1-29

Abstract: This paper reviews previous studies on fiscal sustainability and conducts a pilot empirical analysis for Japan. In Section I, we summarize the definition of fiscal sustainability and the argument over sovereign defaults. Section II outlines the transversality condition as a typical formulation of fiscal sustainability. Section III introduces money and examines the transversality condition of nominal values. In this setting, the fiscal theory of the price level(FTPL), which asserts that the transversality condition is satisfied by price fluctuations, becomes valid. Section IV discusses three issues, taking into account the comparison of interest rates and economic growth rates (i.e., the Domar condition). First, based on the Domar condition, we discuss the equivalence/non-equivalence between the transversality condition and the convergence of the government debt-to-GDP ratio. Second, we consider the Domar condition from the perspective of dynamic efficiency and its implications for fiscal sustainability. In particular, we suggest that in the case where ɡ > r, a rational bubble can arise in government debt and that convergence of the government debt-to-GDP ratio below a certain value (rather than the transversality condition) is an appropriate sustainability indicator. Third, we conduct an empirical analysis(stochastic debt sustainability analysis: SDSA) when there is uncertainty in r − ɡ. According to our calculations, when there is uncertainty in r − ɡ, even if the current situation is ɡ > r, Japan’s government debt-to-GDP ratio could be very large in 2030.

Keywords: fiscal sustainability; transversality condition; fiscal theory of the price level(FTPL); seigniorage; Domar condition; rational bubble; stochastic debt sustainability analysis(SDSA) (search for similar items in EconPapers)
JEL-codes: E31 E62 H63 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:mof:journl:ppr19_03_02

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