Panel cointegration tests of the sustainability hypothesis in rich OECD countries

Abstract

This study reexamines the sustainability hypothesis by testing whether government revenues and expenditures for eight rich OECD countries between 1977Q1 and 2005Q4 are cointegrated. For this purpose, a nonstationary panel data approach is adopted, which is general enough to permit for cross-country dependence as well as structural breaks representing major shifts in fiscal policy. In contrast to many earlier studies, the results reported in this study suggest that the sustainability hypothesis cannot be rejected.

Acknowledgement

Westerlund gratefully acknowledges financial support from the Jan Wallander and Tom Hedelius Foundation, research grant number W2006–0068:1.

Notes

¹Note that 1/(1 + i*) = (i + σ)/(1 + i), where i and σ are the mean values of i_t and σ_t , respectively. Thus, if i < σ, then the transversality condition is satisfied automatically.

²Note that the case with β > 0 is not consistent with a deficit, since revenues are growing faster than expenditures.