Why Fiscal Regimes Matter for Fiscal Sustainability: An Application to France

This paper introduces a Regime-Switching Model-Based Sustainability test allowing for periodic (or local) violations of Bohn (1998, QJE)’s sustainability condition. We assume a Markov-switching fiscal policy rule whose parameters stochastically switch between sustainable and unsustainable regimes. We demonstrate that long-run fiscal sustainability not only depends on regime-specific feedback coefficients of the fiscal policy rule but also on the average durations of fiscal regimes. Evidence on French data suggests that both the No-Ponzi Game condition and the Debt-stabilizing condition hold in the long-run, when accounting for fiscal regimes, contrary to standard MBS tests.