Sustainability of budget deficits: An application for European Union countries and Turkey

ivABSTRACTSUSTAINABILITY OF BUDGET DEFICITS:AN APPLICATION FOR EUROPEAN UNION COUNTRIES AND TURKEYHüseyin KALYONCUPh. D. Dissertation, Department of EconomicsSupervisor: Prof. Dr. E. Alper GÜVELDecember 2005, 179 pages?Sustainability? is perhaps the most frequently used word in economic policy makingcircles in the 1990s; sustainable development, sustainable environmental policies, sustainabledebt and deficits level. Importance of a sustainable budget policy has been increasingly in thescope of economist and policy makers. In principle, an economy will be able to sustaindeficits, whether internal or external, as long as it can raise the necessary funds by borrowing.Although such behavior may be feasible in the short run, the ability of the economy to serviceits debt by resorting to further borrowing is likely to be questioned once the deficits becomepersistent.The concept of sustainability of budget deficit has been studied in recent years by alarge literature. There are three major approaches in the literature to ascertain budget deficitsustainability; Intertemporal Budget Constraint (IBC) or Present Value Constraint (PVC)approach, accounting approach and sustainability indicators. PVC or IBC approach impliesthat the discounted value of future primary surpluses equals the outstanding stock ofgovernment debt. Budget deficit is sustainable if the intertemporal budget constraint holds inpresent value terms. Thus, the current debt should be offset by the sum of expected futurediscounted primary budget surpluses. A violation of government intertemporal budgetconstraint would indicate that the budget deficits are not sustainable and that the budgetpolicy must be changed.The goal of this study is to test the sustainability of 18 countries? budget deficit byusing intertemporal budget constraint theory.Keywords : Budget Deficit, Sustainability, European Union, Cointegration.