Stochastic Trends, Debt Sustainability and Fiscal Policy

By Karim Barhoumi, Reda Cherif, Nooman Rebei

March 10, 2016

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Karim Barhoumi, Reda Cherif, and Nooman Rebei. Stochastic Trends, Debt Sustainability and Fiscal Policy, (USA: International Monetary Fund, 2016) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We study empirically the reaction of fiscal policy to changes in the permanent and transitory components of GDP in a panel of countries. We find evidence that government spending tends to be counter-cyclical conditional on temporary shocks and pro-cyclical conditional on permanent shocks. We also find no evidence that developing countries are systematically different from developed ones in terms of fiscal policy. We present a theory featuring a fiscal reaction function to the output gap and a measure of debt sustainability. The fiscal impulse response to a permanent (temporary) shock to GDP is positive (negative) as the effect on debt sustainability (current output gap) dominates. The results are mostly sensitive to the relative weight of debt sustainability in the fiscal reaction function as well as to the extent of real rigidities in the economy.

Subject: Debt sustainability, Expenditure, External debt, Fiscal policy, National accounts, Personal income, Public debt

Keywords: Business cycles, Cyclicality, Debt expectation, Debt ratio, Debt sustainability, Fiscal policy, Government spending cyclicality, Government spending decision rule, Government spending policy, Government spending rule, Government spending tend, Output deviation, Personal income, Public debt, WP

Publication Details

Pages:

45
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/059
Stock No:

WPIEA2016059
ISBN:

9781513574677
ISSN:

1018-5941

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