Fiscal sustainability in an emerging market economy: when does public debt turn bad?

• Main Authors: Baharumshah, Ahmad Zubaidi, Soon, Siew Voon, Lau, Evan
• Format: Article
• Language: English
• Published: Elsevier 2017
• Online Access: http://psasir.upm.edu.my/id/eprint/61893/1/Fiscal%20sustainability%20in%20an%20emerging%20market%20economy.pdf; http://psasir.upm.edu.my/id/eprint/61893/; https://www.sciencedirect.com/science/article/pii/S0161893816300990

This paper proposes a Markov-switching model to assess the sustainability of fiscal policy in Malaysia for the period 1980–2014. Our results indicate the policymakers in the past have followed a sustainable fiscal policy, except during the brief periods of economic difficulty. The empirical analysis reveals that the government should cut the deficits only if they exceed a certain level, to ensure their sustainability in the long-run. Specifically, we find that after public debt exceeds a certain threshold level (above 55% of the gross domestic product), it is negatively correlated with economic activity. In addition to the threshold effect, we confirm the presence of a unidirectional causal relation between debt and growth.