Short-Run Dynamic Effects of Debt Changes on the Primary Budget Surplus

This paper provides a modification of Bohn(1998)'s test for the sustainability of fiscal policy. The new aspect of the alternative test lies in the emphasis of the short-run adjustment of the primary budget surplus in a response to changes in debt. To capture the short-run dynamic effects of debt increase on the primary surplus, we use a structural VAR model whose identification is given by exploiting the period-by-period budget equation. A basic impulse-response analysis then can show how governments react to increases of debt. As an empirical illustration, the new method is applied to the real data from South Korea.