Abstract:
Public debt levels are reaching dimensions that were unthinkable decades ago. Recent developments have given rise to a new paradigm regarding sustainable debt levels. This new outlook finds substantial support in this inquiry. The popular fiscal reaction test by Bohn (1998) is used to determine whether countries show a sufficient
direct fiscal response to the growing gross debt levels. The panel data estimation indicates that there is significant proof that countries jointly adhere to a mean reversion process, suggesting sustainable fiscal policy. Time series analysis shows that Denmark, France, Germany, Japan, Norway Portugal, Spain, the UK, and the USA exhibit a sustainable policy. Greece and Italy have unsustainable policies, while Belgium and Finland show inconclusive results. The impact of the COVID-19 pandemic is also investigated by analysing forecasts of the IMF (2021) for 2021-2026. Surprisingly, most countries tend to have stronger mean reversion when the predictions of the IMF are included, giving this research an interesting twist.
