Regime shifts in stock-flow I(2)-I(1) systems: the case of US fiscal sustainability

Abstract

SUMMARYIn the last two decades, fiscal sustainability has been tested through the use of non-stationary time series analysis. Two different approximations can be found in the literature: first, a univariate approach that has focused on the stochastic properties of the stock of debt and, second, a multivariate one that has focused on the long-run properties of the flows of expenditures and revenues, i.e., in the stochastic properties of the deficit. In this paper we unify these approaches considering the stock-flow system that fiscal variables configure. Our approach involves working in an I(2) stochastic processes framework. Given the possibility of the existence of regime shifts in the sustainability of US deficit that the literature has pointed out, we develop a new statistic that can be applied to test several types of I(2) cointegration and multicointegration relationships allowing for regime shifts. To test for these kinds of changing long-run relationships we propose the use of a residual-based Dickey-Fuller class of statistic that accounts for one structural break. We show that consistent estimates of the break fraction can be obtained through the minimization of the sum of squared residuals when there is I(2) cointegration. The finite sample performance of the proposed statistic is investigated by Monte Carlo simulations. The econometric methodology is applied to assess whether the US fiscal deficit and debt are sustainable.

Fiscal Deficit Sustainability of the Spanish Regions

“…The DOLS estimates of the long-run relationship reveal that in eight out of seventeen cases,^ i is statistically signi…cant, being positive in six cases -Andalusia, Castilla and León, Catalonia, Galicia, Madrid and the Basc Country -and negative in two cases -Valencia and Navarre. 12 Thus, for nine out of seventeen ACs,^ i is not statistically signi…cant. This picture di¤ers from that drawn using the pooled estimate of and indicates that although the …scal de…cit is sustainable according to Bohn's de…nition from an aggregated point of view, there is heterogeneous behaviour across the Spanish ACs.…”

Sustainability and comovement of government debt in EMU Countries: A panel data analysis

“…Table reports studies on fiscal sustainability for the United States. Hamilton and Flavin (), Trehan and Walsh (), Tanner and Liu (), Quintos (), Martin (), Arestis, Cipollini, and Fattouh (), Cunado, Gil‐Alana, and Perez de Gracia (), Bohn (), Payne and Mohammadi (), Bajo‐Rubio, Díaz‐Roldán, and Esteve (), Berenguer‐Rico and Carrion‐i‐Silvestre (), Mahdavi and Westerlund (), and Mahdavi () found substantial evidence in favor of the sustainability of U.S. fiscal policy. Conversely, Wilcox (), Abeysinghe and Jayawickrama (), and Hatzinikolaou and Simos () showed results in line with the unsustainability hypothesis.…”

The Behavior of U.S. Public Debt and Deficits During the Global Financial Crisis

“…Makrydakis et al (), Papadopoulous and Sidiropoulos (), and Jha and Sharma () employ the ZA (1992) unit root test, while the latter two studies apply the Gregory and Hansen () cointegration test. Martin () and Berenguer‐Rico and Carrion‐I‐Silvestre () use a different approach to test for the expenditure–revenues cointegration relationship while allowing for structural breaks. Specifically, the former uses a Bayesian approach whereas the latter study develops a new test statistic that can be employed to test for I(2) cointegration and multiple cointegration relationships.…”

“…Hakkio and Rush () find that the cointegrating slope coefficient of government expenditure is significantly smaller than unity for the sample period 1950–1988, suggesting that revenues do not respond adequately to increases in expenditures to achieve fiscal sustainability. Be that as it may, there are cointegration tests with structural breaks that point to the evidence that the U.S. fiscal policy is sustainable (see Berenguer‐Rico and Carrion‐I‐Silvestre ; Cunado et al ; Martin ; Quintos ).…”