Government Solvency: Revisiting some EMU Countries

Abstract

Corsetti and Roubini (1991) reported that the government finances of Greece, Ireland, Italy and the Netherlands (now all EMU countries) did not satisfy the intertemporal budget constraint (IBC). We re-examine this issue by utilizing a new empirical approach and extended data set. Structural shifts, an issue which Corsetti and Roubini were unable to address due to the lack of suitable econometric methods, are tackled. We find that: (i) multiple structural shifts, most of which correspond to important policy changes, did occur in the fiscal path of these countries; (ii) the effect of the majority of structural shifts has been to strengthen the evidence supporting IBC; and (iii) government finances of all four countries satisfy the IBC and this finding is robust to different time horizons. We also find a clear positive Maastricht effect on IBC for all countries.intertemporal budget constraints, strong and weak form sustainability, structural breaks