Estimating a Time-Varying Fiscal Reaction Function to Appraise Public Debt Sustainability in Turkey: 1970 - 2017

Abstract

This thesis appraises the public debt sustainability in Turkey by estimating a fiscal reaction function in time-invariant and time-varying (state space) settings. Succinctly speaking, this function gauges the scale of fiscal responses in the form of primary balance improvements to trim the excessive upward movements in the public debt so as to bring in a verdict about the level of fiscal sturdiness in the country. The data set used for this estimation covers the 1970-2017 period. According to the findings, the time-invariant estimation results are indicative of public debt sustainability albeit in a narrow perspective for the entire sample whereas time-varying estimation results point out to a transformation in the fiscal reaction rather than strict sustainability. The evolution of fiscal reaction parameter exhibits a shift from negative to positive which corresponds to a transition from unsustainable to sustainable debt position. This transformation trimmed the adverse effects of the concurrent positive snowball effect on debt dynamics and thereby initiated the public debt sustainability during early 2000s which did not exist before. The empirical findings are also suggestive of the fact that recent fiscal performance is not on a par with the past achievements and the fiscal reaction strength of Turkey has been waning gradually during the late 2010s. Coupled with worsening growth and real interest rate environment, the recent gradual downturn in the fiscal reaction competence of the government emits risks of a looming debt crisis reminiscent of 2001 whose impairing effects can swiftly permeate all sectors of the economy. In order to preserve sustainability, this trend should be reversed in a timely manner by policy alterations. Reducing extravagance and profligacy in public sector for restoring commitment to fiscal discipline through a back-loading adjustment and a full-fledged tax system restructuring are among the potential policies to be considered for facilitating the required primary balance generation.