Interpretation and limits of sustainability tests in public finance

G. Lamé, Matthieu Lequien and P.-A. Pionnier
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G. Lamé: Insee
P.-A. Pionnier: Insee

Documents de Travail de l'Insee - INSEE Working Papers from Institut National de la Statistique et des Etudes Economiques

Abstract: Public debt is considered sustainable if discounted net repayments are expected to cover the initial debt issuance, i.e. if the government intertemporal budget constraint is expected to hold. With risk averse lenders and an uncertain economic environment, Bohn (1995) stresses that this constraint relies on a stochastic discount factor which depends on lenders' preferences. To get round the difficulty related to the specification of private agents' preferences in empirical analysis, Bohn (1998) suggests to estimate fiscal reaction functions describing how primary surplus reacts to indebtedness. After having solved the econometric issues arising when primary surplus and debt have a very different persistence (with a non-parametric approach) or are both integrated (with parametric tests), we estimate fiscal reaction functions for France and for Greece. The empirical results highlight the remaining limitations and interpretation difficulties that plague these econometric sustainability tests.

Keywords: Intertemporal budget constraint; unit-roots; cointegration; fiscal reaction function; non-parametric tests (search for similar items in EconPapers)
JEL-codes: C12 E62 F34 H60 H62 (search for similar items in EconPapers)
Date: 2013
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Journal Article: Interpretation and limits of sustainability tests in public finance (2014)
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