The name is absent

impact on debt dynamics, especially in the second half of the 1990s. During most of the
last decade, primary surpluses have been ubiquitous.

Although informative about debt developments and the contribution of different budget
components to debt accumulation, data in Tables 2.1 and 2.2 convey scarce information
about the sustainability of fiscal policy. For example, one might be tempted to interpret
the fact that budget deficits have been the norm in our sample as indicative of underlying
Ponzi games. However, sustainability conditions impose very weak constraints in the
behaviour of deficits. As a matter of fact, sustainability is compatible with permanent
budget deficits as long as they induce a debt growth rate lower than the discount rate.⁷
Similarly, a declining debt-to-GDP ratio might be seen as indicative of fiscal
sustainability, but it is actually compatible with Ponzi schemes whereby the government
rolls over a given level of debt when the interest rate on government debt is lower than
the GDP growth rate. This analysis above suggests in fact that commonly used fiscal
indicators may be misleading as signals of sustainability and that more formal approaches
are needed in order to establish whether a given fiscal policy is sustainable.

2.4 Determinants of the Fiscal Primary Surplus

Baseline Model

In accordance with the fiscal reaction function approach to sustainability discussed in
section 2.2, we start with the following basic specification of the determinants of the
primary surplus:

s_t = c + δ d_t-1 +γ x_t + ρ s_t-1 + ε_t                                               (2.10)

The motivation for equation (2.10) is to capture the potential response of the primary
surplus to debt, while trying to avoid omitted variable bias. To that end we include two
components considered important in government fiscal behaviour. On the one hand, the
response to the cyclical conditions of the economy, as represented by the output gap x. On
the other hand, the inertial process typically associated with fiscal policy that is captured
by the primary surplus lag. Finally, equation (2.10) incorporates a random term
representing other potential factors affecting the evolution of the primary surplus, as for
example non-systematic discretionary policy actions.

Figure 2.1 plots the three series involved in equation (2.10) for each one of the 16
countries in the sample. As already pointed out in Section 2.3, there seems to be in a
number of countries a positive correlation between the primary surplus and the stock of
debt at the end of the previous period. Interestingly, although one would have expected a
strong positive correlation between primary surpluses and output gaps, so primary
balances would improve in times of positive output gaps, Figure 2.1 seems to suggest that
in a number of countries such an automatic counter-cyclical behaviour of the primary
balances has been offset by pro-cyclical discretionary fiscal policies.

Sustainability is even compatible with policies that may generate primary deficits on average, as for
example fiscal policies that targeting debt/output stabilization require a surplus or a deficit depending
on output fluctuations.

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