Do Governments React to Public Debt Accumulation? A Cross-Country Analysis

TL;DR

This paper investigates how governments across 52 countries adjust fiscal policies in response to rising public debt, revealing widespread debt-responsive behavior and Ricardian fiscal strategies.

Contribution

It provides empirical evidence that governments respond to debt increases with fiscal adjustments, using panel methods that account for cross-country differences and heterogeneity.

Findings

A 10-percentage-point debt increase raises primary surplus by 0.5% of GDP.

Fiscal adjustments are consistent across high- and low-debt countries.

Governments tend to avoid Ponzi financing, indicating Ricardian policies.

Abstract

Do governments adjust budgetary policy to rising public debt, precluding fiscal unsustainability? Using budget data for 52 industrial and emerging economies since 1990, we apply panel methods accounting for cross-sectional dependence and heterogeneous fiscal conduct. We find that a primary-balance rule with tax-smoothing motives and responsiveness to debt has robust explanatory power in describing fiscal behavior. Controlling for temporary output, temporary spending, and the current account balance, a 10-percentage-point increase in the debt-to-GDP ratio raises the long-run primary surplus-to-GDP ratio by 0.5 percentage points on average. Corrective adjustments hold across high- and low-debt countries and across industrial and emerging economies. Our results imply many governments pursue Ricardian policy designs, avoiding Ponzi-type financing.