The Global Dimension to Fiscal Sustainability

A PANIC test on the difference between the primary surplus and debt (see
Table 3) identifies one nonstationary common factor. FE and Bai and Kao (2005) are
therefore inappropriate estimators in this case, as the relationship between primary
surplus and debt is de-coupled by a nonstationary common factor.

Consequently, we use the Bai et al. (2007) test which allows for the possibility
of nonstationary factors in estimating a cointegrating panel regression. In Table 2, we
obtain a significant and positive coefficient on the CupBC estimation procedure
(0.018 and t = 7.3). This suggests that fiscal policy is responsive to the level of debt,
although the CupBC estimated fiscal response to debt is around half of the level
suggested by Mendoza and Ostry (2007).

<Insert Table 4 here>

4.3 Emerging Market Economies Result

Turning now to the emerging markets data, as in the case of the industrial
countries, we first pre-test the data to examine whether there is evidence of
nonstationarity, using the Bai and Ng (2004) PANIC test. As can be seen in Table 4,
PANIC Panel Unit Root tests on the debt/GDP and primary surplus cannot reject the
null of a unit root. In both cases, the nonstationarity originates in the common
components of Debt/GDP and primary surplus, highlighting the importance we
believe of the nonstationary factor approach. Interestingly the fact that the debt/GDP
ratio is also nonstationary is indicative of unsustainable debt, according to the
approach of Hamilton and Flavin (1986).¹⁴

¹⁴ Although recall the caveat of Bohn (2007).

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