How Reliable are Budget Sustainability Tests? A Case Study for Greece

In this paper we try to answer if the empirical evidence on the Greek fiscal policy has been consistent with the government intertemporal budget constraint during two tested periods, 1833-2009 and 1960-2009. The recent Greek debt crisis provides a unique opportunity to test whether sustainability tests produce what they ought to produce: We know that the Greek debt is unsustainable, so do the sustainability tests show the same? We use several common approaches such as Johansen approach, DOLS, Engle-Granger approach, Bohn test and finally Trehan-Walsh approach. Our results are mixed and in contrast with our expectations, because the majority of the tests indicate sustainable fiscal policy in both tested periods. One reason for the non-performance of the sustainability tests may be that they do not include information provided by rating agencies (which may not always be rational). Another important limitation of the present value budget constraint is the assumption of infinite growth of the economy. Additionally, the budget deficit is one of the most important fiscal instruments, and based on previous data processes.