Debt and deficit ceilings, and sustainability of fiscal policies: An intertemporal analysis

TY - JOUR

T1 - Debt and deficit ceilings, and sustainability of fiscal policies: An intertemporal analysis

AU - Uctum, M

AU - Wickens, M

PY - 2000/5

Y1 - 2000/5

N2 - In this paper we examine the likely consequences for the sustainability of fiscal policy of pursuing goals that rely on restictive ceilings on deficits and debt. We provide a formal theoretical framework for analyzing the sustainability of fiscal policy based on the government intertemporal budget constraint and derive conditions that determine whether a given fiscal stance is sustainable. This framework generalizes the existing literature in several important respects. We allow for time-varying interest rates, for feedback from debt to the primary deficit, for a finite planning horizon suitable for medium-term policy making, for possible future policy shifts, we show how published forecasts can be used and we provide a measure of fiscal pressure. We then apply this analysis to the fiscal positions of the United States and the European Union countries since 1970 and to their planned positions over the next decade.We find that many countries do not have a sustainable policy. The evidence in favour of sustainablitly is strengthened for most countries when the data are extended to incorporate future fiscal consolidation plans, reflecting the general shift toward fiscal austerity in recent years. In contrast, with a finite horizon we show that the recent policy shift made the paths of future policies sustainable. However, imposing ceilings on debt or deficit-to-GDP ratios throws most economies onto an intertemporally inconsistent path unless governments undertake a major tax or expenditure adjustment. High-debt countries can satisfy debt rules only by raising (reducing) the average tax (spending) rate substantially for five years. A deficit ceiling puts an increasingly high pressure on most economies, including the United States, requiring a gradual rise (decline) in the tax (spending) rate. We conclude therefore that imposing debt or deficit ceilings could lead to fiscal policy becoming a difficult political choice.

AB - In this paper we examine the likely consequences for the sustainability of fiscal policy of pursuing goals that rely on restictive ceilings on deficits and debt. We provide a formal theoretical framework for analyzing the sustainability of fiscal policy based on the government intertemporal budget constraint and derive conditions that determine whether a given fiscal stance is sustainable. This framework generalizes the existing literature in several important respects. We allow for time-varying interest rates, for feedback from debt to the primary deficit, for a finite planning horizon suitable for medium-term policy making, for possible future policy shifts, we show how published forecasts can be used and we provide a measure of fiscal pressure. We then apply this analysis to the fiscal positions of the United States and the European Union countries since 1970 and to their planned positions over the next decade.We find that many countries do not have a sustainable policy. The evidence in favour of sustainablitly is strengthened for most countries when the data are extended to incorporate future fiscal consolidation plans, reflecting the general shift toward fiscal austerity in recent years. In contrast, with a finite horizon we show that the recent policy shift made the paths of future policies sustainable. However, imposing ceilings on debt or deficit-to-GDP ratios throws most economies onto an intertemporally inconsistent path unless governments undertake a major tax or expenditure adjustment. High-debt countries can satisfy debt rules only by raising (reducing) the average tax (spending) rate substantially for five years. A deficit ceiling puts an increasingly high pressure on most economies, including the United States, requiring a gradual rise (decline) in the tax (spending) rate. We conclude therefore that imposing debt or deficit ceilings could lead to fiscal policy becoming a difficult political choice.

KW - BUDGET CONSTRAINT

M3 - Article

SN - 0305-9049

VL - 62

SP - 197-+

JO - Oxford Bulletin of Economics and Statistics

JF - Oxford Bulletin of Economics and Statistics

IS - 2

ER -