Fiscal Sustainability in European Countries:A Preliminary Analysis

Abstract

This paper examines fiscal sustainability in fifteen European countries. Motivated by the statistical power of the advances in panel unit root tests, we apply these new tools to test whether or not the fiscal imbalance is sustainable in the long run. We also employ the exponential smoothing transition unit root test (ESTAR) to account for the non-linearity of the fiscal imbalance. The empirical evidence shows that the traditional unit roots cannot be rejected at the conventional level, suggesting that the fiscal imbalances for these countries are not stationary processes and are thus unsustainable. Evidence from the panel unit roots shows that the fiscal imbalances of Belgium, Finland, Greece, Italy, the Netherlands, Portugal, Spain and Sweden are stationary processes. The ESTAR unit root test results show that, except for the Netherlands, fourteen out of fifteen countries are non-linear stationary processes. In sum, the evidence shows that the fiscal imbalances of the fifteen European countries meet their intertemporal long-run budget constraints, implying that these countries have no incentive to default on their debt.