An empirical investigation of the sustainability of the public deficit in Portugal

Abstract

In this paper, we investigate Portuguese government expenditures and revenues as an example for a long time series. Our hypothesis states that there may be periods when the deficit is sustainable and those when it is not. Usually, after a period of unsustainable deficits, a new regime takes over. These regime shifts call for an approach that takes into account a non-constant structure of the underlying data generating process. Consequently, we use different tests which we set up in a time-varying framework. We apply and compare the results of the Trace test, Breitung’s non-parametric test and the Bohn test. We identify several break points and find that the Trace test performs worst in this case while Breitung’s test and the Bohn test give similar results. Comparing the results with history, we find that the last two tests best reflect what happened historically.