Review of World Economics

, Volume 145, Issue 4, pp 731–755

What do we really know about fiscal sustainability in the EU? A panel data diagnostic

Original Paper


We assess the sustainability of public finances in the EU-15 over the period 1970–2006 using stationarity and cointegration analysis. Specifically, we use panel unit root tests of the first and second generation allowing in some cases for structural breaks. We also apply modern panel cointegration techniques developed by Pedroni (Oxf Bull Econ Stat 61(1):653–670, 1999; Econom Theory 20(3):597–625, 2004), generalized by Banerjee and Carrion-i-Silvestre (Cointegration in panel data with breaks and cross-section dependence, European Central Bank, Working Paper 591, 2006) and Westerlund and Edgerton (Econ Lett 97(3):185–190, 2007), to a structural long-run equation between general government expenditures and revenues. While estimations point to fiscal sustainability being an issue in some countries, fiscal policy was sustainable both for the EU-15 panel set, and within sub-periods (1970–1991 and 1992–2006).


Intertemporal budget constraint Fiscal sustainability EU Panel unit root Panel cointegration 

JEL Classification

C23 E62 H62 H63 


  1. Afonso, A. (2005). Fiscal sustainability: The unpleasant European case. FinanzArchiv, 61(1), 19–44.CrossRefGoogle Scholar
  2. Afonso, A. (2008). Ricardian fiscal regimes in the European Union. Empirica, 35(3), 313–334.CrossRefGoogle Scholar
  3. Afonso, A. & Rault, C. (2007). What do we really know about fiscal sustainability in the EU? A panel data diagnostic (Working Paper 820). Frankfurt a.M.: European Central Bank.Google Scholar
  4. Ahmed, S., & Rogers, J. (1995). Government budget deficits and trade deficits. Are present value constraints satisfied in long-term data? Journal of Monetary Economics, 36(2), 351–374.CrossRefGoogle Scholar
  5. Banerjee, A. & Carrion-i-Silvestre, J. (2006). Cointegration in panel data with breaks and cross-section dependence (Working Paper 591). Frankfurt a.M.: European Central Bank.Google Scholar
  6. Banerjee, A., Marcellino, M., & Osbat, C. (2004). Some cautions on the use of panel methods for integrated series of macro-economic data. Econometrics Journal, 7(2), 322–340.CrossRefGoogle Scholar
  7. Banerjee, A., Marcellino, M., & Osbat, C. (2005). Testing for PPP: Should we use panel methods? Empirical Economics, 30(1), 77–91.CrossRefGoogle Scholar
  8. Bergman, M. (2001). Testing government solvency and the no ponzi game condition. Applied Economics Letters, 8(1), 27–29.CrossRefGoogle Scholar
  9. Bohn, H. (1998). The behavior of U.S. public debt and deficits. Quarterly Journal of Economics, 113(3), 949–963.CrossRefGoogle Scholar
  10. Breitung, J., & Pesaran, M. (2005). Unit roots and cointegration in panels. In L. Matyas & P. Sevestre (Eds.), The econometrics of panel data. Boston: Klüver Academic Press.Google Scholar
  11. Breuer, J., McNown, R., & Wallace, M. (2002). Series-specific unit root tests with panel data. Oxford Bulletin of Economics and Statistics, 64, 527–546.CrossRefGoogle Scholar
  12. Chang, Y., Park, J., & Song, K. (2006). Bootstrapping cointegrating regressions. Journal of Econometrics, 133(2), 703–739.CrossRefGoogle Scholar
  13. Choi, I. (2006). Combination unit root tests for cross-sectionally correlated panels. In D. Corbae, S. Durlauf, & B. Hansen (Eds.), Econometric theory and practice: frontiers of analysis and applied research, essays in honor of Peter C. B. Phillips. Cambridge: Cambridge University Press.Google Scholar
  14. Claeys, P. (2007). Sustainability of EU fiscal policies: A panel test (Documents de Treball 2007/02). Institut de Recerca en Economia Aplicada, University of Barcelona.Google Scholar
  15. Domar, E. (1944). The ‘burden of debt’ and the national income. American Economic Review, 34(4), 798–827.Google Scholar
  16. Fève, P., & Hénin, P. (2000). Assessing effective sustainability of fiscal policy within the G-7. Oxford Bulletin of Economic Research, 62(2), 175–195.CrossRefGoogle Scholar
  17. Fisher, R. (1932). Statistical methods for research workers. London: Oliver and Boyd.Google Scholar
  18. Gutierrez, L. (2006). Panel unit roots tests for cross-sectionally correlated panels: A Monte Carlo comparison. Oxford Bulletin of Economics and Statistics, 68(4), 519–540.CrossRefGoogle Scholar
  19. Hakkio, G., & Rush, M. (1991). Is the budget deficit ‘too large?’. Economic Inquiry, 29(3), 429–445.Google Scholar
  20. Hamilton, J., & Flavin, M. (1986). On the limitations of government borrowing: A framework for empirical testing. American Economic Review, 76(4), 808–816.Google Scholar
  21. Haug, A. (1991). Cointegration and government borrowing constraints: Evidence for the United States. Journal of Business & Economic Statistics, 9(1), 97–101.CrossRefGoogle Scholar
  22. Im, K. & Lee, J. (2001). Panel LM Unit Root Test with Level Shifts (Discussion paper). Department of Economics, University of Central Florida.Google Scholar
  23. Im, K., Pesaran, M., & Shin, Y. (2003). Testing for unit roots in heterogeneous panels. Journal of Econometrics, 115(1), 53–74.CrossRefGoogle Scholar
  24. Keynes, J. (1923). A tract on monetary reform. In The collected writings of John Maynard Keynes, vol. IV, London: Macmillan, (1971 edition).Google Scholar
  25. Lee, J., & Strazicich, M. (2003). Minimum Lagrange multiplier unit root test with two structural breaks. Review of Economics and Statistics, 85(4), 1082–1089.CrossRefGoogle Scholar
  26. Levin, A., Lin, C.-F., & Chu, C.-S. (2002). Unit root tests in panel data: Asymptotic and finite sample properties. Journal of Econometrics, 108(1), 1–24.CrossRefGoogle Scholar
  27. Lyhagen, J. (2000). Why not use standard panel unit root test for testing PPP (Working Paper No. 413). Stockholm: Stockholm School of Economics.Google Scholar
  28. MacDonald, R. (1992). Some tests of the government’s intertemporal budget constraint using US data. Applied Economics, 24(12), 1287–1292.CrossRefGoogle Scholar
  29. McCallum, B. (1984). Are bond-financed deficits inflationary? A ricardian analysis. Journal of Political Economy, 92(1), 123–135.CrossRefGoogle Scholar
  30. McCoskey, S., & Kao, C. (1998). A residual-based test of the null of cointegration in panel data. Econometric Reviews, 17(1), 57–84.CrossRefGoogle Scholar
  31. Moon, H., & Perron, B. (2004). Testing for a unit root in panels with dynamic factors. Journal of Econometrics, 122(1), 8–126.CrossRefGoogle Scholar
  32. O’Connell, P. (1998). The overvaluation of purchasing power parity. Journal of International Economics, 44(1), 1–19.CrossRefGoogle Scholar
  33. Park, J. (2002). An invariance principle for sieve bootstrap in time series. Econometric Theory, 18(2), 469–490.CrossRefGoogle Scholar
  34. Payne, J. (1997). International evidence on the sustainability of budget deficits. Applied Economics Letters, 12(4), 775–779.CrossRefGoogle Scholar
  35. Pedroni, P. (1996). Fully modified OLS for heterogeneous cointegrated panels and the case of purchasing power parity (Working paper in economics No. 96-020). Bloomongton: Indiana University.Google Scholar
  36. Pedroni, P. (1999). Critical values for cointegrating tests in heterogeneous panels with multiple regressors. Oxford Bulletin of Economics and Statistics, 61(1), 653–670.CrossRefGoogle Scholar
  37. Pedroni, P. (2000). Fully modified OLS for heterogeneous cointegrated panels. Advances in Econometrics, 15, 93–130.CrossRefGoogle Scholar
  38. Pedroni, P. (2004). Panel cointegration; asymptotic and finite sample properties of pooled time series tests with an application to the purchasing power parity hypothesis. Econometric Theory, 20(3), 597–625.CrossRefGoogle Scholar
  39. Pedroni, P., & Urbain, J.-P. (2001). Cross member cointegration in non-stationary panels. Mimeo: Universtiteit Maastricht.Google Scholar
  40. Pesaran, M. (2004). General diagnostic tests for cross section dependence in panels (Cambridge Working Papers in Economics, No. 435), University of Cambridge.Google Scholar
  41. Phillips, P. (2001). Bootstrapping spurious regressions (Cowles Foundation Discussion Paper No. 1330). Yale.Google Scholar
  42. Phillips, P., & Perron, P. (1988). Testing for a unit root in time series regression. Biometrika, 75(2), 335–346.CrossRefGoogle Scholar
  43. Phillips, P., & Sul, D. (2003). Dynamic panel estimation and homogeneity testing under cross-section dependence. Econometrics Journal, 6(1), 217–259.CrossRefGoogle Scholar
  44. Prohl, S. & Schneider, F. (2006). Sustainability of public debt and budget deficit: Panel cointegration analysis for the European union member countries (Working Paper No. 0610). Department of Economics, Johannes Kepler University Linz.Google Scholar
  45. Quintos, C. (1995). Sustainability of the deficit process with structural shifts. Journal of Business & Economic Statistics, 13(4), 409–417.CrossRefGoogle Scholar
  46. Schmidt, P., & Phillips, P. (1992). LM tests for a unit root in the presence of deterministic trends. Oxford Bulletin of Economics and Statistics, 54, 257–287.Google Scholar
  47. Tanner, E., & Liu, P. (1994). Is the budget deficit ‘too large’? Some further evidence. Economic Inquiry, 32, 511–518.CrossRefGoogle Scholar
  48. Taylor, M., & Sarno, L. (1998). The behavior of real exchange rates during the post-bretton woods period. Journal of International Economics, 46(2), 281–312.CrossRefGoogle Scholar
  49. Taylor, A., & Taylor, M. (2004). The purchasing power parity debate. Journal of Economic Perspectives, 18(4), 135–158.CrossRefGoogle Scholar
  50. Trehan, B., & Walsh, C. (1991). Testing intertemporal budget constraints: Theory and applications to U.S. federal budget and current account deficits. Journal of Money Credit and Banking, 23(2), 206–223.CrossRefGoogle Scholar
  51. Uctum, M., & Wickens, M. (2000). Debt and deficit ceilings, and sustainability of fiscal policies: An intertemporal analysis. Oxford Bulletin of Economic Research, 62(2), 197–222.CrossRefGoogle Scholar
  52. Westerlund, J. & Edgerton, D. (2007). A panel bootstrap cointegration test. Economics Letters, 97(3), 185–190.CrossRefGoogle Scholar
  53. Wilcox, D. (1989). The sustainability of government deficits: Implications of the present-value borrowing constraint. Journal of Money Credit and Banking, 21(3), 291–306.CrossRefGoogle Scholar
  54. Zivot, E., & Andrews, D. (1992). Further evidence of the great crash, the oil-price shock and the unit-root hypothesis. Journal of Business and Economic Statistics, 10(3), 251–270.CrossRefGoogle Scholar

Copyright information

© Kiel Institute 2009

Authors and Affiliations

  1. 1.European Central BankFrankfurt am MainGermany
  2. 2.Department of Economics, UECE—Research Unit on Complexity and EconomicsISEG/TULisbon—Technical University of LisbonLisbonPortugal
  3. 3.LEO, University of OrléansOrléans Cedex 2France
  4. 4.BEM, Bordeaux Management SchoolBordeauxFrance

Personalised recommendations