Multicointegration, Sustainability of Fiscal Practices and the Role of Fiscal Institutions

Using the multicointegration methodology first presented in Granger and Lee (1989, 1990) and further developed by Engsted, Gonzalo and Haldrup (1997) and Haldrup (1998) we develop criteria for testing sustainability of the fiscal budgeting process. We then apply this criteria to the fiscal systems of fifteen industrialized countries. Finland, Norway, the U.K. and Switzerland display government budgeting behavior consistent with sustainable fiscal practices. Evidence indicates that the budgeting practices of Belgium, Canada, Denmark, France, Greece, Italy, the Netherlands, Portugal, Spain, Sweden and the U.S. are inconsistent with practices that are sustainable. The findings suggest that over the sample period the governments of these last eleven countries may have been trying to exploit low rates of interest relative to growth or execute a Ponzi scheme. However, should growth decline, sustainability of the fiscal processes may become problematic necessitating structural adjustments. The evidence further suggests that reforming budgetary institutions in such a manner as to make them stronger, more hierarchical and transparent will mitigate the pressures to pursue fiscal profligacy.