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Fiscal sustainability in an emerging market economy: When does public debt turn bad?

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  • Baharumshah, Ahmad Zubaidi
  • Soon, Siew-Voon
  • Lau, Evan

Abstract

This paper proposes a Markov-switching model to assess the sustainability of fiscal policy in Malaysia for the period 1980–2014. Our results indicate the policymakers in the past have followed a sustainable fiscal policy, except during the brief periods of economic difficulty. The empirical analysis reveals that the government should cut the deficits only if they exceed a certain level, to ensure their sustainability in the long-run. Specifically, we find that after public debt exceeds a certain threshold level (above 55% of the gross domestic product), it is negatively correlated with economic activity. In addition to the threshold effect, we confirm the presence of a unidirectional causal relation between debt and growth.

Suggested Citation

  • Baharumshah, Ahmad Zubaidi & Soon, Siew-Voon & Lau, Evan, 2017. "Fiscal sustainability in an emerging market economy: When does public debt turn bad?," Journal of Policy Modeling, Elsevier, vol. 39(1), pages 99-113.
    • Handle: RePEc:eee:jpolmo:v:39:y:2017:i:1:p:99-113
    DOI: 10.1016/j.jpolmod.2016.11.002
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    More about this item

    Keywords

    Endogenous multiple breaks; Fiscal sustainability; Debt; Economic growth;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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