Macroeconomics and Politics in the Accumulation of Greece's Debt: An Econometric Investigation, 1975-2009

Working Paper no 10-2013, Department of Economics, Athens University of Economics and Business

37 Pages Posted: 29 Nov 2013

See all articles by George Alogoskoufis

George Alogoskoufis

Athens University of Economics and Business

Date Written: January 15, 2013

Abstract

This paper focuses on an econometric investigation of the macroeconomic and political factors that contributed to Greece’s excessive debt accumulation and its failure to adequately address its fiscal imbalances, from the restoration of democracy in 1974 till the crisis of 2009. The econometric investigation is based on a model in which two political parties alternate in power, and in which governments choose primary expenditure and taxes to minimize deviations from politically determined expenditure and tax targets, subject to a debt accumulation equation. The model predicts a political equilibrium in which primary expenditure and taxes follow feedback rules which go in the direction of stabilizing the debt to GDP ratio. However, this stabilization incentive is weaker in election years. The model also predicts potential partisan differences in the evolution of primary expenditure and taxes, due to the different preferences of political parties. Estimates of government reaction functions to public debt for the period 1975-2009 suggest a rather weak stabilizing reaction of primary deficits to public debt. This stabilizing reaction disappears in election years, which are characterized by strong fiscal expansions. We find no evidence of partisan differences in the reaction of primary deficits to inherited debt, but we do find evidence of lower primary deficits in the post-1992 Maastricht treaty period. Overall the model accounts for the accumulation of Greece’s government debt in terms of the trend increase in primary expenditure, the positive shocks to primary expenditure in election years and the weak stabilizing reaction of government revenue, due to tax smoothing.

Keywords: macroeconomics and politics, government debt, primary deficit, stabilization, elections, political parties, Greece

JEL Classification: E6, H6, C5

Suggested Citation

Alogoskoufis, George, Macroeconomics and Politics in the Accumulation of Greece's Debt: An Econometric Investigation, 1975-2009 (January 15, 2013). Working Paper no 10-2013, Department of Economics, Athens University of Economics and Business, Available at SSRN: https://ssrn.com/abstract=2360268 or http://dx.doi.org/10.2139/ssrn.2360268

George Alogoskoufis (Contact Author)

Athens University of Economics and Business ( email )

76 Patission Street
GR-10434 Athens
Greece

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