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

Do governments react to the accumulation of public debt, ruling out an unsustainable course of public finances? As debt has massively increased to counter global financial and pandemic crises, this is a central question for public policy analysis. We examine budget data in a balanced panel of 52 industrial and emerging market economies since 1990. We infer the scope for corrective budgetary measures by employing econometric methods that account for global interdependencies and heterogeneous fiscal policy conduct. We show that a primary-balance feedback policy rule incorporating tax-smoothing objectives and explicitly responding to changes in outstanding debt has robust explanatory power in describing the behavior of fiscal policymakers across countries. Controlling for temporary output, temporary spending, and the current account balance, fiscal retrenchment exhibits a long-run upward adjustment in the primary surplus-GDP ratio by 0.5 percentage points on average in response to an increase in the debt-GDP ratio by 10 percentage points. The conditional response of primary surpluses to debt remains significantly positive when splitting the panel into high-and low-debt countries and into industrial and emerging countries. Our empirical results imply that a large number of governments in advanced and emerging economies do not engage in Ponzi’s games and satisfy the intertemporal budget constraint via a Ricardian fiscal policy design. JEL Classification: E62; H62; H63; H20; H50; C23.