A Time-Varying Fiscal Reaction Function for Brazil

Abstract

This paper evaluates the sustainability of public debt in Brazil using monthly data from January 2003 to June 2016, based on the estimation of fiscal reaction functions with time-varying coefficients. Three estimation methods are considered: Kalman filter, penalized spline smoothing and time-varying cointegration. Besides indicating that the reaction of the primary deficit to variations in the debt/GDP ratio declined over most of the analyzed period, all these methods lead to the conclusion that the Brazilian public debt, given the parameters then in force, reached an unsustainable trajectory in the last years of the sample.

An alert on the recent fall of the fiscal reaction in Brazil

“…The data indicates a non-sustainable public debt trajectory. As in Campos and Cysne (2018), we reject the constant-coefficients hypothesis for the Brazilian fiscalreaction function for all the study period, reinforcing the relevance of applying time-varying coefficient methods.…”

“…This section draws on Campos and Cysne (2018) to derive a condition on debt sustainability in the present framework. It requires that the fiscal-reaction coefficient to be big enough to compensate for the positive difference between real-interest and GDP growth rates.…”

“…The underlying idea is to assess if, and to what extent, fiscal revenues and expenditures react to the evolution of the debt/ GDP ratio. This paper draws on Campos and Cysne (2018) to investigate two specific issues. First, the fall of the fiscal-reaction function in the more recent period, leading to negative values of this coefficient as of October/2017; and second, the robustness of the results achieved Campos and Cysne (2018) regarding an alternative concept of government.…”

“…This paper draws on Campos and Cysne (2018) to investigate two specific issues. First, the fall of the fiscal-reaction function in the more recent period, leading to negative values of this coefficient as of October/2017; and second, the robustness of the results achieved Campos and Cysne (2018) regarding an alternative concept of government. The database is extended, relatively to Campos and Cysne (2018), to a different definition of government and to a more recent period.…”

“…A complete description of these variables is presented at the fourth section. In both cases, we extend the analysis presented in Campos and Cysne (2018) and work with two definitions of government: the "Consolidated Public Sector (CPS)" and the, so called, "General Government (GG)". In Figure 1, PSND and GGND stand for the net debt, respectively, of the Consolidated Public Sector and of the General Government.…”