Sustainability of Public Debt and Budget Deficit: PROHL, Silika and SCHNEIDER, Friedrich *) Working Paper No July 2006

Transcription

1 DEPARTMENT OF ECONOMICS JOHANNES KEPLER UNIVERSITY OF LINZ Susanably of Publc Deb and udge Defc: Panel conegraon analyss for he European Unon Member counres by PROHL, Slka and SCHNEIDER, Fredrch *) Workng Paper No July 2006 Johannes Kepler Unversy of Lnz Deparmen of Economcs Alenberger Srasse 69 A-4040 Lnz - Auhof, Ausra fredrch.schneder@jku.a phone +43 (0) , (fax)

2 1 Susanably_ doc July 2006 Susanably of Publc Deb and udge Defc: Panel conegraon analyss for he European Unon Member counres * by SILIKA PROHL** Unversy of S. Gallen, SIAW-HSG and FRIEDRICH SCHNEIDER*** Unversy of Lnz - Deparmen of Economcs; CESfo (Cener for Economc Sudes and Ifo Insue for Economc Research); Insue for he Sudy of Labor (IZA) Absrac In hs sudy, we analyse he susanably of fscal polcy of EU member counres whn he panel conegraon and error-correcon frameworks. Unlke he prevous emprcal papers n hs area, we apply he es for panel conegraon beween he prmary budge defc and he publc deb defned n GDP raos. ased on he conegraon es resuls, we conclude ha he fscal polcy s conssen wh he neremporal budge consran,.e., s susanable n he panel of ffeen EU member counres over he perod from 1970 o Hence, we show ha he fscal balance exhbs a sgnfcan srucural change n he year 1992, when we apply he anerjee and Carron--Slvesre (2006) es for a srucural break n he panel conegraon relaonshp. In a nex sep, we search for he polco-economc facors whch explan he varaon n he susanable fscal balance among he European counres. We evdence ha he European fscal rules have a sgnfcan posve effec on he mprovemen of he fscal poson of he governmens of he EU member counres. Keywords: JEL Classfcaon: Susanably, udge Defc; Panel Conegraon, Srucural reaks, Panel error-correcon mehod H62, H63, C32 *) Revsed Verson, June Paper o be presened a he CESfo Conference on Enlargng he Euro Area, Munch, November Malng Address: **) Slka Prohl ***) Fredrch Schneder Unversy of S. Gallen Unversy of Lnz SIAW-HSG Deparmen of Economcs odansrasse 8 Alenbergersr. 69 CH-9000 S. Gallen Slka.Prohl@unsg.ch A-4040 Lnz-Auhof Fredrch.Schneder@jku.a hp://

3 2 1 Inroducon In recen years, growng aenon s pad o fscal susanably n Europe. oh, he deb and he defc crera, whch are defned n he Maasrch Treay, and he Sably and Growh Pac are relevan o ensure he susanably and sablzaon of he publc fnance n he European Unon (EU) member counres. The Treay ses he maxmum lms of he budge defc-gdp rao for an enry no he moneary unon a hree percen and allows for he long-run deb convergence abou 60 percen of GDP (by assumng he rend growh of hree percen and he rend nflaon of wo percen). The Sably and Growh Pac, whch nroduces he fnancal fne for he volaon of he defc crera, requres he balanced fscal poson or he budgeary surplus n he medum-run. Followng he dscusson abou he poenal effecs of he fscal polcy nsuons n he EU, a number of emprcal sudes examnes he susanably of he budge defc and publc deb, and he mpac of he fscal rules on he mprovemen of he fscal poson of he governmens n he EU member counres. These sudes dffer wh respec o he mehodologcal approaches used o examne he susanably hypohess, and he resuls repored. Caporale (1995) sudes he susanably of he fscal polcy n en European unon counres, and repors he susanable fscal balance for elgum, France, Ireland, he Neherlands, Span, and he UK, whle evdences he volaon of he neremporal budge consran for Denmark, Germany, Greece, and Ialy. Vanhorebeek e al. (1995) apply he es for saonary of he prmary budge defc- and he deb-gdp raos o he sample of egh European counres over he perod from 1970 o 1994 n order o sudy he susanably. They evdence he saonary prmary budge defc rao for France, Denmark, and Germany, whle fal o verfy hs hypohess for Ireland, Ialy, and he Neherlands. Hence, hey demonsrae he susanable publc deb-gdp rao only for he UK, and fnd he rendsaonary rao for elgum and Denmark. An equvalen framework s used by Papadopoulus e al. (1999). They apply he es for conegraon beween he revenue and expendure wh he vecor (1, -1) n order o examne he susanably hypohess for he sample of fve European Unon counres over he perod from 1961 o Gven he large budge defc and growng publc deb-gdp rao n hese counres over he me perod under sudy, hey fnd ha he revenue and expendure are conegraed wh he coeffcen sgnfcanly lower han one for Greece, Span, and Porugal. Ths observaon mples ha he neremporal budge consran s fulflled snce he revenue and expendure are n her long-run equlbrum relaonshp, bu he governmens have he problem o manage her explodng publc deb. Furhermore, hey demonsrae he volaon of he neremporal budge consran for Ialy and elgum. ravo and Slvesre (2002) apply hs es for conegraon o he sample of eleven European Unon counres over he perod from 1960 o They verfy he susanably hypohess for Ausra, France, Germany, he Neherlands, and he UK, and repor s volaon for elgum, Denmark, Fnland, Ireland, Ialy, and Porugal. Payne (1997) uses he same mehodology o sudy he fscal susanably n he sample of he G-7 counres, and fnds suppor only for Germany and he UK. In a more

4 3 recen sudy, Afonso (2005) explores he same framework o sudy he susanably n he sample of ffeen EU member counres. He demonsraes ha he revenue and expendure are conegraed only for Ausra, Fnland, Germany, and he Neherlands, bu shows ha he conegraon coeffcen s sgnfcanly lower han one. Furhermore, for elgum, Denmark, Porugal, and he UK, he fnds he sgnfcan srucural break n he conegraon relaonshp beween he revenue and expendure whch fundamenally changes he srucure of he fscal balance. Unlke he prevous sudes, n hs paper we examne he susanably hypohess n he panel of ffeen EU member counres over he perod from 1970 o To avod he problem of he former sudes, whch apply he convenonal me-seres ess o he relavely shor me-seres, we use he panel conegraon framework. The emprcal sraegy of he sudy s as follows. In a frs sep, we employ he es for he panel-conegraon beween he prmary budge defc and publc deb gven ha boh seres are non-saonary and are of he same order of negraon. Hence, as he crera defned n he Maasrch Treay and he Sably and Growh Pac are regarded as suffcen condons o ensure he fscal susanably, n a nex sep, we examne wheher hese nsuons have sgnfcan mpac on he mprovemen of fscal poson of he governmens n he EU area whn he panel errorcorrecon approach. The paper s organsed as follows. Secon 2 presens he heorecal framework and dscusses he exsng emprcal leraure. Secon 3 provdes a dscusson of he me seres. Furhermore, presens he panel un roo ess resuls and moves on o he panelconegraon es resuls. Secon 4 connues he analyss wh he model of susanable budge defc and presens he emprcal resuls for he panel of 15 European counres. Secon 5conans concludng remarks. 2 Revew of he Emprcal Leraure and Theorecal Framework Whn he panel framework, where = 1,..., T are he me seres observaons on = 1,..., N counres, he heorecal approach of fscal susanably uses he budge consran of he governmen defned by (1) G, + (1+, ),-1 = R, +,, where, represens he sock of publc deb, whle, denoes he ex-pos neres rae for publc deb; R, s he governmen revenue ncludng he revenue from segnorage, and G, s he expendure excludng neres paymens, respecvely. Defnng he governmen budge consran n erms of GDP-raos, we can rewre equaon (1) as (2) G Y,, (1+, ) + (1+ σ ) Y,,-1,-1 R = Y,, + Y,,,

5 4 where Y, s he nomnal GDP, and σ, denoes he nomnal GDP-growh rae. Defnng he lower-case leers as raos of he correspondng upper-case varables o nomnal GDP, we smplfy he equaon (2) for he analyss as (3) g, + (1+ *, ) b,-1 = r, + b,, where *, s he neres rae adjused for he economc growh rae, gven by *, = ((1+, ) / (1+ σ, ) -1). y suggesng ha equaon (3) holds for each perod, and assumng he consan neres rae, we can rewre he neremporal budge consran for he perod from τ = o τ = T when performng he forward subsuon as N 1 1 (4) b, -1 = s + τ, τ 1 lm b,τ 1, + τ = 1 τ= + 1 (1 * ) τ (1+ * ) where s, denoes he prmary budge surplus defned by s, = r, - g,. The leraure derves he condon of susanable fscal polcy dependng on he rajecory of developmen of he second erm of condon (4). If suggesng ha he ransversaly condon holds,.e., 1 (5a) lm b 0 τ,τ 1 =, τ (1+ * ) he neremporal budge consran of he governmen s gven by (5b) b, -1 = N = 1 τ= (1+ * ) τ s, τ 1. Condon (5a), whch s known as he no Ponz game rule requres ha he publc deb mus no grow a a rae greaer han he neres rae. If hs condon s fulflled, hen he neremporal budge consran mples he equaly beween he sock of he marke value of publc deb and he sum of dscouned fuure budge surpluses. If hs condon s vald, he heory predcs he fscal polcy of he governmen o be susanable. Sarng wh condon (5) as a esable relaon, he emprcal leraure proposes several frameworks o examne he susanably hypohess. One drecon of he sudes suggess es for he saonary of he prmary budge surplus n order o check wheher he ransversaly condon holds. Gven he relaon (5) as a esable condon, Hamlon and Flavn (1986) make he assumpon abou he consan real neres rae, and suggesng he consan volaon of he neremporal budge consran (.e., A,0 > 0 ), hey derve he esable hypohess by N 1 1 (6) b, -1 = s + τ. τ 1 A,0. = 1 τ= + 1 (1+ * ) (1+ * ) They argue ha he null hypohess ha he neremporal budge consran s fulflled s vald f and only f A,0 = 0. They defne he saonary of he prmary budge defc as a suffcen

6 5 condon for fscal polcy o be susanable. However, Wlcox (1989) derves he condon for susanable fscal polcy whch suggess ha he dscouned value of publc deb mus go o zero n he nfne fuure when allowng for he me-varyng neres rae. N r 1 1 (7) g, -1 = r,-1 + ( r + τ, τ 1 - g,τ 1 ) lm b,τ 1 + τ = 1 τ= + 1 (1 * ) τ (1+ * ) where r, τ and g, τ, are assumed o be saonary. Followng condon (7), and assumng ha he ransversaly condon holds, Qunos (1995) defnes he conegraon beween he r revenue r, and expendure g, wh conegrang coeffcen close o one, gven ha boh seres are non-saonary and of he same order of negraon, as he necessary and suffcen condon for neremporal budge consran o be vald, whle he conegraon wh 0 ˆ β < 1 s only a suffcen condon. < Fnally, an alernave mehod o examne wheher he daa are conssen wh he neremporal budge consran requres sudyng he conegraon relaonshp beween he publc deb and he prmary budge defc gven f boh seres are non-saonary processes. -1 MacDonald (1992) proposes o subrac s, 1 from boh sdes of he relaon (5b), dervng he followng esable hypohess by N 1 1 (8) b, -1 - s,-1 = * = 1 τ= + 1 (1+ *) τ (s, τ 1 s, τ 2 ). An equvalen o he Hamlon and Flavn s (1986) framework of esng for saonary of he prmary budge defc mples examnaon of he conegraon relaonshp beween he revenue and expendure wh conegrang vecor (1, -1). Hakko and Rush (1991), and Qunos (1995) n order o derve he esable condon propose o rewre he relaon (5) wh r he oal governmen expendure g, = g, + *, b,- 1 as -1 Here, he defnes ha he erm s, τ 1 s, τ 2 resuls from he suggeson of as he sum of he weghs on s, τ 1. Ths condon (8) mples ha he es, whch s based on he examnaon of saonary of s, τ 1 s equvalen o he es for saonary of he lnear combnaon ( * b,-1 - s,- 1 ). Sarng wh he relaon (8), and usng he Engle-Granger (1987) defnon, gven ha he model s fully specfed, he conegraon mples he exsence of one parameer * whch guaranees ha he lnear combnaon (9) s - * b ε,, = s saonary n levels,.e., I(0)-process; suggess ha he prmary budge defc and publc deb are conegraed. The equlbrum relaonshps are gven hen by (10) s, = * b,,,

7 6 where he vecor β ' = (1, - * ) s he conegrang vecor. Equvalenly, followng he Granger represenaon heorem (Engle-Granger, 1987, p.255f.), he conegraon beween he budge defc and publc deb can be expressed by usng he error-correcon represenaon, whch s gven by (11) s, = α + λ ( s,-1 - * b,-1 ) + δ,s s,-1 + δ,b b,-1 + u,, where he erm λ s he adjusmen coeffcen, and u, s whe nose, whch may be conemporaneously correlaed. Ths model descrbes he varaons n budge defc and publc deb around her long-run rends, and he error-correcon (s, -1 - * b,- 1), whch s he equlbrum error n he conegraon model. Sascally sgnfcan erm λ suppors he hypohess ha he prmary budge surplus and he publc deb are conegraed, and shows ha he error-correcon model s a vald represenaon of he daa. In hs conex, he errorcorrecon model shows ha alhough he developmen of he prmary budge defc and publc deb may dverge n he shor run, he fscal varables wll adjus when devaon beween hem dffer from he equlbrum developmen, so ha n he long run he budge defc and publc deb wll move ogeher. In he projecon of he fuure fscal polcy varables on he nformaon se n he perod, s mporan o assume ha he governmen budge consran resrcs he jon movemens of he budge defc and publc deb. Applyng hese resuls, we can formulae he followng esable hypohess. Hypohess 1 The fscal polcy sasfes he neremporal budge consran (.e., susanable), f he prmary budge defc and he publc deb are conegraed. Hence, he relaon (11) mples ha he varaon n susanable fscal balance among he European Unon Member counres n he panel can be explaned by some nsuonal facors. As we wan o deermne he facors whch have an nfluence on he mprovemen n he fscal balance, we examne addonally he followng esable hypoheses. Hypohess 2 Ths hypohess argues ha he susanably of he governmen fnance n he EU area closely relaes o he commmen of he Maasrch Treay (rafed n Maasrch n 1992) and he Sably and Growh Pac (SGP) (rafed on June 1997 n Amserdam). We expec he resrcve effec of he European fscal rules on he ncrease n budge defc-gdp rao.

8 7 Hypohess 3 Moreover, he budgeary performance and he capacy of he governmens o mee he crera of susanable fscal polcy can be affeced by he process of decenralzaon wh ncreased dvson of he budgeary responsbles beween he dfferen levels of he governmen. The heory predcs he negave relaonshp beween he susanable fscal balance and he degree of fscal decenralzaon of he governmen. Hypohess 4 The nex hypohess sudes he mpac of he polcal cycles on he susanably of he fscal balance. oh, he heorecal and emprcal leraures sugges he sgnfcan effec of he polcal cycles on he fscal polcy oucome; he governmens are wllng o provde more expansonary fscal polcy n he pre-elecon me perod (Nordhaus, 1975, Frey and Schneder, 1978 a and b, Alesna, Roubn and Cohen, 1997). Ths lne of he leraure predcs ha n a more polcally unceran envronmen, he governmen shows s wllngness o ncrease he expendure before he parlamenary elecons and o leave he hgher publc deb for he nex governmen Hypohess 5 Anoher drecon of he leraure sudes he effec of he elecoral laws on fscal polcy oucome (Persson and Tabelln, 1999). Usng hs approach, Persson and Tabelln (1999) show ha counres wh majoraran elecon rules end o have larger redsrbuon programmes and he sze of publc secor. Ths leraure predcs ha he varaons n fscal polcy oucome can be explaned by he dfferences n he elecoral sysems (majoraran vs. proporonal). 3 Emprcal Mehodology, Daa and Resuls 3.1 Emprcal Mehodology Thus, n hs sudy, we examne hs susanably of he fscal balance n he panel of nne EU member counres over he perod from 1970 o The emprcal sraegy of he sudy s as follows. In he frs sep, we employ he es for panel conegraon beween he marke value of he publc deb and he prmary budge defc defned as GDP raos n order o es he Hypohess 1. Provded ha he defc- and deb-gdp raos are conegraed, we conclude ha he fscal polcy n he EU area s conssen wh he neremporal budge consran,.e., s susanable. Furhermore, we sugges ha he conegraon relaonshp mpled by he neremporal budge consran may no be sable over he whole me perod consdered;

9 8 may exhb sgnfcan srucural breaks caused by he changes n he naonal and nernaonal fscal polcy rules. To sudy hese shfs, we apply he anerjee and Carron-- Slvesre (2006) es for srucural break n he panel conegraon relaonshp. And fnally, we use an alernave, error-correcon represenaon n order o re-examne he hypohess wheher he budge defc and he publc deb are conegraed. Addonally, we search for he polco-economc facors whch explan he varaon n he susanable fscal balance among he European counres whn he error-correcon approach when examnng he Hypoheses (2)-(5). 3.2 Daa We examne he susanably of he publc deb and he budge defc n he panel of ffeen European Unon counres over he perod from 1970 o The daa for all counres are aken from he European Commsson AMECO (Annual Macroeconomc Daa) daabase, updaed n December Counres ncluded n he sample are Ausra, elgum, Denmark, Fnland, France, Germany, Greece, Ireland, Ialy, Luxembourg, he Neherlands, Porugal, Span, Sweden, and Uned Kngdom. The seres nclude general governmen publc deb, prce deflaor of fnal prvae consumpon expendures, and he gross domesc produc (GDP). For he analyss, we employ he fscal seres defned as GDP raos. The raos are obaned by dvdng her nomnal values by he GDP. The sources of he daa are gven n he Appendx, Table A Resuls In he frs sep, we examne he saonary properes of he ndvdual me seres, he prmary budge defc and he publc deb, boh defned n GDP raos for each counry when we apply he Augmened Dckey-Fuller (ADF), he Phllps-Perron (PP), and DF-GLS es n order o provde he comparably and he benchmark for he resuls reporer laer. The number of lags s chosen by usng he Hannan-Qunn nformaon creron. We perform he un roo ess for he varables n levels and frs dfferences. The resuls for each of he ffeen European counres are depced n Table 1. [Inser Table 1 abou here] Followng he leraure, whch defnes he dfference-saonary of he publc deb as he suffcen condon for he neremporal budge consran o be vald (Trehan and Walsh, 1991), we apply he es for un roo o he publc deb-gdp rao for he ndvdual counres. The es resuls evdence ha hs rao s dfference-saonary (.e., I(1)-seres) for Ausra,

10 9 Fnland, France, Germany, Greece, Ireland, Luxembourg, he Neherlands, Porugal, Sweden, and he UK. Excepons are he deb seres for elgum, Denmark, Luxembourg, and he UK. In a nex sep, we check an alernave susanably condon whch mples examnaon of wheher he prmary budge defc s saonary n levels (.e., I(0)-seres) when we apply he same se of he ess o he defc-gdp rao for he ndvdual counres. The ADF- and PPess mply he saonary of he prmary budge defc-gdp rao for Germany, Luxembourg, Sweden, and he UK. The leraure suggess he low power of he convenonal un roo ess n he case of shor me span (T=34), and of he hgh perssence n he model,.e., f he domnan roo s close o uny (Ng and Perron, 1999). Therefore, we carry ou he panel un roo ess whch combne he me seres and he cross-seconal nformaon for he panel daa (see Maddala and Wu, 1999). The frs es appled s he Levn and Ln (LL)-es (1993) whch s an exenson of he sandard Dckey-Fuller es o he panel framework. I akes he heeroscedascy and auocorrelaon n he panel no consderaon. The lmaon of he LL-es s he assumpon of homogeney and ndependen error erms across cross-seconal uns. As he LL-es uses a very resrcve hypohess, and s of lle praccal neres, we conduc addonally he Im, Pesaran and Shn (IPS) (1997) es whch s based on he assumpon of he heerogeneous parameers. Whle he IPS es as a paramerc, asympoc es examnes he sgnfcance of he es resuls from N ndependen ess of he null hypohess, an alernave approach s used by he non-paramerc Fsher (1932) es whch s an exac one; combnes he p-values from he ndvdual un roo ess (Maddala and Wu, 1999). The asympoc resuls for he laer wo ess depend on dfferen condons: he resuls of he IPS-es depend on he number of he cross-secon uns, whle hose of he Fsher es depend on he number of he me observaons n he panel. The LL-, IPS-, and he Fsher-ess resuls are presened n Table 2. These resuls mply ha he publc deb-gdp rao s saonary n he frs dfferences (.e., I(1)-seres). Hence, shows ha he prmary budge defc-gdp rao can be defned as I(1)-seres by usng he LLes. [Inser Table 2 abou here] Consequenly, we rea boh seres, he publc deb- and he budge defc-gdp raos as I(1)- seres and sudy he conegraon beween hese varables n order o examne he conssency of he fscal polcy wh he neremporal budge consran n he panel of ffeen European counres n a nex sep Panel conegraon analyss

11 10 Nex, we examne he queson of wheher he fscal polcy fulfls he neremporal budge consran by conducng he es for conegraon beween he prmary defc- and publc deb-gdp raos n a panel of ffeen EU counres. The leraure defnes several approaches o perform he panel conegraon es; see anerjee (1999) for he overvew of he panelconegraon ess. One approach, whch s analogous o he bvarae Engle-Granger (1987) es, examnes he null hypohess of no conegraon by usng he resduals from he panel conegraon model (Pedron, 1999). The Pedron (1999) framework works wh he resduals from he followng conegraon regresson (12) d = α + β Trend + δ b ε, where,,, + d s he prmary budge defc-gdp rao, δ = (δ, δ,..., δ ), T s he number, 1 2 M of observaons over me ( = 1,2,..., T ), N denoes he number of counres n he panel ( = 1,..., N), and M s he number of regressors ( m = 1,..., M ). Here, he erm Trend denoes he me rend, and ε, s he error erm. Ths model allows for he heerogeneous slope coeffcens, fxed effecs and he ndvdual specfc deermnsc rends. In order o perform hs panel conegraon es, Pedron (1997) develops seven dfferen es-sascs. Here, we use wo of hese sascs, he paramerc - sasc whch s seen as an analogous o he Levn and Ln panel un roo sasc appled o he esmaed resduals of conegrang regresson (12), and he paramerc group -sascs whch s consdered as an analogue o he IPS group mean un roo sasc when appled o resduals of regresson (12). For boh ess, he suffcenly large negave values of calculaed es-sascs mean he rejecon of he null hypohess of no conegraon. In a frs sep, we proceed o es for conegraon beween he defc- and deb-gdp raos by applyng he Engle-Granger (1987) es o he ndvdual counry daa. Ths mehod s based on he ordnary-leas squares (OLS) resduals ˆε from he conegrang regresson (12) for each ndvdual counry n he sample and examnes he null hypohess of no conegraon. The resuls of he es are repored n Table 3. The able depcs he ADF- and DW-es values for he model (12) and he esmaed conegrang coeffcens by usng he OLS. The resuls allow rejecng he null hypohess of no conegraon for a large group of counres. For France, Germany, Luxembourg, Porugal, Sweden, and he UK, here s srong evdence n favour of conegraon beween he prmary defc- and deb-gdp raos ha mples he conssency of he fscal polcy wh he neremporal budge consran. [Inser Table 3 abou here]

12 11 In a nex sep, we conduc he Pedron (1997, 1999) panel conegraon es n order o examne he susanably hypohess. The resuls are gven n Table 4 for he conegrang model (12) when we esmae addonally he model wh he alernave dependen varable. The model s esmaed by ncludng he counry-fxed effecs. Here, we depc wo essascs proposed by Pedron (1997), he panel and he group -sascs. The es resuls ndcae ha he null hypohess of no panel conegraon can be rejeced by he group -sasc for he model when he defc-gdp rao s a dependen varable. If we esmae he model wh he deb-gdp rao as a dependen varable, we fal o rejec he null hypohess. [Inser Table 4 abou here] Overall, he resuls of he panel conegraon es verfy he hypohess ha he defc- and deb-gdp raos are conegraed n he panel of ffeen EU member counres over he perod from 1970 o anerjee and Carron--Slvesre (2006) es for srucural breaks n conegraon relaons Hence, we addonally examne he effecs of possble srucural breaks on he sably of conegraon relaon by applyng he anerjee and Carron--Slvesre (2006) mehodology. Ths approach s an exenson of he Gregory-Hansen (1996) es o he panel framework developed by Pedron (1997, 1999). anerjee and Carron--Slvesre (2006) analyse seven dfferen cases when he srucural shfs have subsanal effec on sably of he resuls of he panel conegraon mehod of Pedron (1999); here, we apply only hree of hese cases. The frs one s relaed o he model whch ncorporaes he srucural change n he level a break pon T b ; he model assumes a sable conegrang vecor. Ths case can be descrbed by model A (13) d = α + β Trend + θ DU + δ b ε, where,,, + DU, s a dummy varable whch s defned by 0 Tb DU, =, 1 > Tb for he gven Tb as he break pon, and Trend as he me rend. The model, whch mus be esmaed o calculae he Pedron (1997) panel daa conegraon es-sasc, ncludes a consan erm (he ndvdual effec) as a deermnsc componen.,

13 12 The model assumes he me rend wh he changes n boh, he level and he rend funcon, bu whch capures he assumpon of sable conegrang vecor. Ths model s gven by (14) d = α + β Trend + θ DU + γ DT + δ b ε, where,,,,, + DT, s a dummy varable defned by 0 Tb DT, =. ( Tb) > Tb The panel conegraon es-sasc s compued by usng he me rend and he deermnsc componen. And fnally, he model C allows for he me rend wh he changes n boh, he level and he slope, and accouns for he shf n he conegrang vecor (15) d = α + β Trend + θ DU + γ DT + δ b ε, where, he conegrang vecor,,,,, + δ, s specfed as a funcon of me by δ,1 Tb δ, =. δ,2 > Tb Usng each of he defned specfcaons of he model, anerjee and Carron--Slvesre (2006) propose o examne null hypohess of no conegraon agans he alernave hypohess of conegraon wh srucural break common for all cross-seconal uns n he panel daa framework as proposed by Pedron (1999, 2004). anerjee and Carron--Slvesre (2006) show ha n he frs case, he shf n levels maers only when he magnude of shf s large and he break occurs a he end of he perod. I follows ha for he small shfs n level, he ncorrec specfcaon error of deermnsc componen does no nfluence he power of Pedron es-sascs. In he second case, he emprcal power of he es dmnshes subsanally f he break occurs eher n he mddle or a he end of he consdered perod. And fnally, n he hrd case, he change n he conegrang vecor can have a moderae or a large dmnshng effec on he power of he es-sasc f he break pon s locaed n he mddle or he end of he perod. The resuls of he IPS(τ)-sascs of he resduals from each of hree esmaed conegrang models (13)-(15) by reang each year over he perod [(0.15T),(0.85T)] as a possble break pon are depced n Fgure 1, and he resuls of he LL(τ)-sascs are repored n Fgure 2. The resuls of boh ess, he IPS- and he LL-es ndcae he sgnfcan srucural break n he year These fndngs confrm wh he assumpon of he effec of nsuonal changes n he EU on he changes n prmary budge defc-gdp rao.,,

14 Model wh level shf Model wh level shf and me rend Model wh level shf, me rend and regme shf Fgure 1: Tes-sascs of he IPS(τ)-es for conegraon beween prmary defc- and publc deb-gdp raos for he perod [(0.15T),(0.85T)] Model wh level shf Model wh level shf and me rend Model wh level shf, me rend and regme shf Fgure 2: Tes-sascs of he LL(τ)-es for conegraon beween prmary defc- and publc deb-gdp raos for he perod [(0.15T),(0.85T)] 4 The deermnans of susanable budge defc n he panel of European counres So far we found, ha he susanably hypohess s verfed n he panel of ffeen EU member counres. In he nex secon, we search for he facors whch explan he varaons n he fscal mbalance among he European counres whn he panel error-correcon approach. We use he dynamc error-correcon mehod (ECM) whch s verfed by he exsence of he conegraon relaon beween he budge defc and publc deb defned n GDP raos (Engle and Granger, 1987). Here, we adop he panel error-correcon mehod as proposed by Cannng and Pedron (1999), whch s a wo-sep mehod. In a frs sep, we esmae he conegrang relaon beween he budge defc and publc deb by usng he ordnary leas-square (OLS) mehod for each ndvdual counry. In a second sep, we use hese esmaed conegrang relaonshps o calculae he non-equlbrum

15 14 ermεˆ = d - αˆ - βˆ Trend - δˆ. Fnally, we esmae he error-correcon model (ECM).,, b, Whn hs approach, he error-correcon erm represens he devaon of he budge defc and publc deb from her long-run equlbrum relaonshp. The advanage of he errorcorrecon mehod s ha snce all varables n he model are saonary, he super-conssency of he esmaor of conegrang relaon allows applyng he sandard ess on sgnfcance of he coeffcens n he regresson (Toda and Phllps, 1993). The rade-off of hs approach s ha we can examne only he exsence and he sgn of he long-run effec, bu we can no nerpre s magnude (Cannng and Pedron, 1999). The error-correcon regresson o be esmaed s defned as T (16) d, = α + β Trend + δ1, j b,- j + δ 2, j d,- j + λ εˆ, -1 + ϕ CV, + u,, j= 1 T j= 1 where boh seres, he prmary budge defc- GDP rao (d, ) and he sock of he publc deb GDP rao (b, ) are I(1)-seres. The erm εˆ, s he error-correcon erm, and denoes he dfference operaor; he varable CV, represens he se of he conrol varables, and u, s he error erm. Subscrps = 1 15 denfy he counres, and = are he years. In order o conrol he oulers, we nroduce he dummy varables n he model (16) (for elgum for he year 1981, Fnland for he 1991, Germany for he 1975, Greece for he 1981, Ialy for he 1975, Luxembourg for he 1982 and he 1983, and Sweden for he years 1984 and he 1991). Economerc analyss s performed by usng he pooled cross-seconal me seres model and he ordnary leas squares (OLS) esmaor wh panel correced sandard errors. The number of lags s chosen so ha he esmaed resduals do no exhb sgnfcan auocorrelaon. Ths model allows us o esmae boh, he shor-run and he long-run relaon beween he defc- and he deb-gdp raos. The shor-run effec of publc deb- on he budge defc-gdp rao s gven by he lagged dfferences of he deb-gdp rao n regresson (13). To check he sgnfcance of hs effec, we conduc he -es for he coeffcen of hs erm n he regresson (16). Hence, we examne he sgnfcance of he δˆ 1, j error-correcon erm. If he coeffcen λˆ of he lagged error-correcon erm s negave and sgnfcanly dfferen from zero, would mply he long-run effec of he publc deb on he budge defc defned as GDP raos. Hence, n order o examne he Hypohess 2 we nroduce wo dummy varables n he regresson (16). The frs dummy varable akes he value one n he year when he Maasrch Treay was approved, and zero oherwse. The second dummy varable, whch accouns for he effecs of he Sably and Growh Pac, akes he value one n he year 1997 n counres of he Euro area, and zero oherwse. Moreover, o es he Hypohess 3 we follow he prevous leraure, and nroduce he dummy varable whch akes he value one for he counres wh he federal srucure of governmen, and zero oherwse. Tesng he Hypohess 4 requres he nroducon of he dummy varable whch akes he value one n he year of he

16 15 parlamenary elecons n each counry n he panel, and zero oherwse. Fnally, examnaon of he Hypohess 5 suggess ncluson of he dummy varable whch accouns for he majoraran elecoral sysems. The descrpon of he varables s gven n he Appendx. The emprcal resuls are gven n Table 5. The esmaed model (16) performs relavely well; capures he shor- and he long-run dynamcs n he varables n a correc way. The Jarque- era es sasc suggess he normaly of dsrbuon of he resduals. The Durbn-Wason es suggess he absence of auocorrelaon n resduals. In a frs sep, we examne he shor-run effec of he publc deb on he budge defc (boh measured n GDP-raos) by conducng he sandard χ 2 - Wald es. Under he null hypohess of no effec, he es sasc follows he ch-squared dsrbuon wh he degrees of freedom equal o he number of resrcons mposed. [Inser Table 5 abou here] Large value of hs sasc allows rejecng he null hypohess. The resuls evdence he sgnfcan posve shor-run effec of he publc deb on he defc-gdp rao. Ths evdence suppors he Rcardan equvalence heorem whch, n order o fulfl he neremporal budge consran, requres he response of he governmen o an ncrease n publc deb by decreasng he prmary budge defc In a second sep, we examne he ssue wheher he publc deb has a long-run effec on he budge defc by applyng he χ 2 - Wald-es as well. The es resuls rejec he null hypohess of no sgnfcan effec a all convenonal levels of sgnfcance; he coeffcen on he error-correcon erm n defc equaon s sgnfcanly negave supporng he heorecal predcon. Nex, we es he hypohess on he mpac of he European fscal polcy rules, he Maasrch Treay, and he Sably and Growh Pac on susanably of he budge defc n he panel of he European Unon member counres by ncludng wo dummy varables. Table 5 demonsraes ha boh dummy varables have sgnfcan negave effec on change n budge defc-gdp rao. Ths evdence suggess ha he nroducon of he EU defc crera s sgnfcanly relaed o he decrease of he prmary budge mbalance over me. Nex, we examne he hypohess of wheher he parlamenary elecons subsanally nfluence he fscal oucome of he governmens n he European counres. The es resuls are depced n Table 5 as well. The coeffcen on dummy varable whch akes he value one n he year of he parlamenary elecons, and zero oherwse s posve and sascally sgnfcan; mples an ncrease n fscal mbalance n he elecon years. These fndngs sugges ha he governmens, facng he elecons provde more expansonary fscal polcy when ncrease he publc expendures and leave he larger publc deb for he fuure governmens. These resuls are compable wh he conclusons of he prevous emprcal

17 16 leraure (Tujula and Wolswjk, 2004, Afonso, 2005). However, we fnd ha neher he majoraran elecoral sysem nor he federal srucure of governmen can explan he deeroraon of he fscal balance n he panel of ffeen EU member counres; boh dummy varables are sascally nsgnfcan by usng hs specfcaon of he model. 5 Concludng remarks The susanably of he fscal polcy of he EU counres s one of he mos wdely nvesgaed ssues n he las years. The fscal framework enforcng he susanably and sablzaon of he publc fnance n he EU counres was mplemened n he Maasrch Treay and he Sably and Growh Pac. The objecve of hs sudy s o examne he susanably of he fscal polcy n a panel ffeen European Unon member counres, and o sudy wheher he menoned European nsuons sgnfcanly conrbue o he mprovemen of her fscal balances. The sudy represens he frs aemp o address he susanably hypohess whn he panel framework n he European counres when examnng he conegraon beween he budge defc and publc deb. The used panel conegraon mehodology has several advanages n comparson o he unvarae analyss appled n he emprcal leraure (Afonso, 2005). Frsly, avods power dsorons of he convenonal un roo and conegraon ess as a resul of he small sze of he sample used. Second, as he budge defc and he publc deb are conegraed, we addonally use he error-correcon represenaon n order o esmae boh, he shor- and he long-run response of he budge defc o an ncrease n he publc deb. Two man pons emerge from he analyss performed. Frsly, we fnd he evdence supporng susanably of he fscal balance n he EU area (Hypohess 1); we show ha he budge defc- and he publc deb-gdp raos are conegraed over he consdered perod. Explorng he analyss for he sngle member counres, we fnd ha he defc- and he deb- GDP raos are conegraed for France, Germany, Luxembourg, Porugal, Sweden, and he UK. These resuls are compable wh he fndngs of he alernave emprcal sudes (Afonso, 2005). For he remanng counres n he sample, we canno rejec he null hypohess of no conegraon. Secondly, we fnd he sgnfcan mpac of he European nsuonal arrangemens on he mprovemen of he fscal polcy oucome n he EU member counres (Hypohess 2). oh nsuons examned, he Maasrch Treay and he SGP have a sgnfcan negave effec on he change n he defc-gdp rao. Ths concluson s based on wo ess conduced: we fnd sgnfcan srucural break n he conegraon relaonshp beween he budge defc- and publc deb GDP raos n he year Hence, we show whn he error-correcon approach ha he nroducon of he Maasrch Treay and he Sably and Growh Pac s negavely relaed wh he change n he budgeary mbalance. As a concluson, he nroducon of EU

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22 21 Appendx A Table 1: Tess for Un Roo and Saonary Model wh consan ADF es PP es DF-GLS es Number of lags Frs Dfferences Model wh consan Number of lags Frs Dfferences Model wh consan Number of lags Frs Dfferences AUT D -2.74* *** *** -1.74* *** *** ** *** EL D ** *** *** * DNK D * *** *** -2.39** *** * ** FIN D *** *** -2.46** *** *** *** FRA D *** *** *** *** *** GER D -3.65*** *** -3.25** *** -2.70** -5.68*** *** *** *** GRE D *** *** *** *** *** IRL D *** *** *** * *** *** ITA D *** * * * *** LUX D -4.23*** *** -4.42*** *** -4.19*** *** -3.32** ** -3.25** *** *** NETH D *** *** -1.97** *** -3.46** * *

23 22 Table 1: Tess for Un Roo and Saonary PRT D *** -2.70* *** -1.65* *** *** *** *** ESP D *** *** *** * *** SWE D -3.13** ** ** -3.01*** *** * ** UK D -3.81*** *** -2.81* *** -2.51** *** -3.25** *** *** All varables are measured n relaon o GNP. D denoes he prmary budge defc-gdp rao, and s he marke value publc deb-gdp rao. The values are he esmaed -sascs.. **, * or ( * ) show ha he correspondng null hypohess can be rejeced a he 1, 5, or 10 percen level, respecvely. The number of lags of he ADF es has been deermned usng he Hannan-Qunn creron. For he PP always 4 lags have been used. Table 2: Panel Un Roos Tess Varables Model wh consan LL-es IPS-es Fsher ADF-es Number of lags Frs Dfferences Model wh consan Number of lags Frs Dfferences Model wh consan Number of lags Frs Dfferences D *** *** *** *** *** *** All varables are measured n relaon o GNP. D denoes he prmary budge defc-gdp rao, and s he marke value publc deb-gdp rao. The values are he esmaed -sascs.. **, * or ( * ) show ha he correspondng null hypohess can be rejeced a he 1, 5, or 10 percen level, respecvely.

24 23 Table 3: Resuls of he Engel-Granger Conegraon Tes Conegrang equaon Resdual regresson Dependen varable ˆβ R 2 SE D.-W. k ADFsasc AUT D 0.05*** *** EL D DNK D 0.06*** *** FIN D 0.14*** *** FRA D 0.04** ** ** GER D 0.02* ** * GRE D 0.05*** *** Table 3: Resuls of he Engel-Granger Conegraon Tes IRL D 0.08**

25 ** ITA D * LUX D 0.43** *** ** ** NETH D 0.04* * PRT D 0.05* ** * ESP D 0.05*** *** SWE D 0.13** ** ** UK D ** ** All varables are measured n relaon o GNP. D denoes he prmary budge defc-gdp rao, and s he marke value publc deb-gdp rao. The values are he esmaed -sascs.. **, * or ( * ) show ha he correspondng null hypohess can be rejeced a he 1, 5, or 10 percen level, respecvely.

26 25 Table 4: Resuls of he Pedron Panel Conegraon Tes Conegrang equaon Resdual regresson D Dependen varable ˆβ R *** (0.007) 1.88*** (0.26) D.-W. k Panel -sasc (paramerc) Group -sasc (paramerc) All varables are measured n relaon o GNP. D denoes he prmary budge defc-gdp rao, and s he marke value publc deb-gdp rao. The values are he esmaed -sascs.. **, * or ( * ) show ha he correspondng null hypohess can be rejeced a he 1, 5, or 10 percen level, respecvely. k s he number of lags of he ADF es. Table 5: Error-correcon model for he panel of 15 European Unon member counres: Dependen varable: frs dfference of he consoldaed budge defc (percen of GDP), D, Varables Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.) Coeff. (-sa.),-1, 0.05* (1.99) 0.05** (2.20) 0.05** (2.23) 0.05** (2.15) 0.05** (2.23) 0.05** (2.01) 0.05** (2.01) 0.05** (1.95) 0.05* (1.99) D,-1, 0.08** (2.14) 0.08** (2.17) 0.08** (2.16) 0.09** (2.35) 0.09** (2.32) 0.09** (2.41) 0.09** (2.40) 0.10** (2.61) 0.10** (2.59) εˆ, *** (5.11) -0.23*** (6.35) -0.23*** (6.37) -0.23*** (6.40) -0.24*** (6.46) -0.26*** (6.80) -0.26*** (6.79) -0.26*** (6.82) -0.26*** (6.83) Consan (0.75) 0.002** (2.56) 0.002* (2.50) (1.27) 0.00 (0.56) 0.001** (2.02) 0.001* (1.76) (0.48) (0.09) Maasrch Treay Dummy *** (4.92) *** (4.95) *** (4.89) *** (4.91) SGPD Dummy *** (5.10) *** (5.08) *** (4.95) *** (4.85) Fed. Srucure Dummy (0.65) (0.59) (0.07) (0.11) (0.28) (0.32) Table 5: Error-correcon model for he panel of 15 European Unon member counres:

27 26 Dependen varable: frs dfference of consoldaed budge defc (percen of GDP), D, Elecon Year Dummy *** (3.03) 0.004*** (3.09) *** (3.13) 0.004*** (3.20) Majoraran Sysem Dummy (1.20) (0.94) Counry-Fxed Effec Yes No No No No No No No No 2 R DW-sascs J-sascs F-es: H 0 : = 0 βˆ β TD 3.48** 4.85** 5.01** 4.65** 5.01** 5.06** 4.07** 3.96** , γ ECT-1, 26.53*** 40.34*** 40.62*** 41.02*** 41.76*** 46.25*** 46.16*** 46.67*** 42.60*** β Maasrch *** 24.52*** 23.95*** 24.17*** β SGP *** 25.84*** 24.52*** 23.55*** All varables are measured n relaon o GNP. D denoes he prmary budge defc-gdp rao, and s he marke value publc deb-gdp rao. The values are he esmaed -sascs.. **, * or ( * ) show ha he correspondng null hypohess can be rejeced a he 1, 5, or 10 percen level, respecvely. Appendx : Daa and sources for 15 counres over he perod Tme seres General governmen publc deb (n naonal currency) Prce deflaor of fnal prvae consumpon expendure General governmen oal revenues (n naonal currency) General governmen oal expendures (n naonal currency) Gross domesc produc (a marked prces) Sources AMECO: Code UDGGL AMECO: Code PCPH AMECO: Code URTG (ESA 1995) and URTGF AMECO: Code UUTG (ESA 1995) and UUTGF AMECO: Code UVGDH (ESA 1995) and UVGD

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