Assessing Fiscal Sustainability in Algeria: a Nonlinear Approach

The main objective of this study is to examine the sustainability of fiscal policy using a nonlinear model approach and a smooth transition autoregressive model (STAR), based on quarterly data ranging from 1964 Q4 to 2012 Q4 on the Algerian budget balance as a percentage of GDP. The results clearly show the existence of threshold effects in the Algerian budget deficit (nonlinear behavior and shift in fiscal policy regime) in the form of a Logistic model (LSTR) containing 2 regimes with one threshold, and depending on the third lag in oil price. Thus, the results support the active deficit and debt management hypothesis, when there is a deviation of the deficit ratio from its equilibrium. Moreover, government authorities intervene by cutting deficits and worsening debt only when they have reached a certain threshold (US $ 83.53 per barrel). On the other hand, nonlinear unit root tests accept the null hypothesis of the unit roots and reject the alternative hypothesis for the stationarity of the STAR nonlinear model. This means that the time series of budget balance is not stationary (not mean reverting characteristic), and therefore cannot sustain the budget deficit in Algeria over the long term. However, the effect of a shock with the same magnitude, but with different sign, will have the same effect on the speed of adjustment towards equilibrium. Moreover, the break dates coincides with the beginning of the sharp rise or a drop in oil prices, which confirms the results of the selection of transition variables in the nonlinear model.