The Global Dimension to Fiscal Sustainability

smooth the business cycle; much in contrast, emerging market economies do not
appear to have room for such welfare enhancing policies.

This paper is organized as follows. In the next section we provide a brief
literature review. In section 3 we outline our methodology. Section 4 presents data
and results for nonstationary panel estimation and evidence of panel cointegration,
based on nonstationary factors. Section 5 identifies the nonstationary factor. Section 6
provides some robustness analysis and section 7 concludes.

2. Literature Review

In this section we review research directly related to our times series approach
to fiscal sustainability. Firstly, however, we set out the Government Budget Identity:

Gt+(1+it)Bt-1=Tt+Bt                                       (1)

where Gt is the level of government primary expenditure (i.e. excluding interest
payments), it is the interest rate, Bt is the debt level, and Tt is the level of government
tax revenue. We can consequently express the level of debt as follows, where θt =
1/(1+ it):

Bt=θt(Tt+1-Gt+1+Bt+1)                                      (2)

By repeated substitutions, assuming a constant future interest rate and solving
forward, the Intertemporal Budget Constraint (IBC) can be derived, which is
equivalent to the expected present value constraint:

∞

Bt = ∑θⁱEt(Tt+1 -Gt+1)                                     (3)

i=1

which will hold as long as the following transversality (no Ponzi games) condition is
satisfied

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