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Size-corrected inference in fiscal policy reaction functions: a three country assessment

Helmut Herwartz () and Malte Rengel
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Helmut Herwartz: Georg-August-University Göttingen
Malte Rengel: Georg-August-University Göttingen

Empirical Economics, 2018, vol. 55, issue 2, 391-416

Abstract: Abstract As a reflection of both strong persistence of debt-to-GDP ratios and correlation of respective innovations with governments’ primary surpluses, standard t-tests in policy reaction functions show actual significance levels that are up to five times larger than their nominal reference. Adopting size-controlled inference by means of Monte Carlo-based and asymptotic Bonferroni critical values, we diagnose fiscal policies in the US and the UK to be sustainable in samples covering more than 100 years. Conditioning on post-WWII subsamples and 5% nominal significance, conventional t-tests signal fiscal sustainability for these countries. In contrast, size-corrected inference hints at a lack of fiscal sustainability and, thus is recommended for the ‘real-time’ monitoring of public debt. The fiscal policy of Portugal is found to lack sustainability irrespective of the considered sample period.

Keywords: Public debt; Sustainability; Unit roots; Bonferroni test; Monte Carlo inference; Predictive regressions (search for similar items in EconPapers)
JEL-codes: C12 C22 E62 H62 H68 (search for similar items in EconPapers)
Date: 2018
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