The Global Dimension to Fiscal Sustainability

changes in global interest rates having a material impact on the behaviour of emerging
market economies.¹⁸

7. Conclusion

This paper examines fiscal sustainability in industrial and emerging market
economies, by combining time series tests used in much of the literature (see inter
alia Hamilton and Flavin, 1986, and Trehan and Walsh, 1991) with the more
economics based approach of Bohn (1998, 2007). The latter emphasizes the
relationship between the primary surplus and the level of government debt as an
indicator of fiscal sustainability. Our work also has implications for the determinants
of fiscal policy in a global context. We believe our approach is sufficiently flexible to
rationalise the country and global determinants of fiscal policy.

For both industrial countries and emerging market economies we find
evidence of a long-run relationship between primary surplus and debt, once we take
account of a common stochastic trend. Moreover we subsequently relate this
stochastic trend to global liquidity. While we find that the fiscal sustainability of
emerging market economies is highly dependent on global liquidity, industrial
countries appear to be affected by this common stochastic trend to a lesser extend. As
a result, fiscal policy in emerging markets appears to be driven by the single pursuit of
fiscal sustainability, while industrial countries can combine a concern with debt
sustainability with a welfare enhancing ability to smooth the business cycle. Unlike
emerging market economies, consistent with neoclassical tax smoothing, industrial
countries are able to run deficits when there are downturns in the economy or to offset
temporary increases in government spending. Our contention is that this is consistent

¹⁸ Uribe and Yue (2006) identify that US interest rates have a material impact upon the business cycle
of emerging market economies.

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