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RESEARCH PRODUCT

Is the budget deficit sustainable when fiscal policy is non-linear? The case of Spain

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In this paper, we re-examine the long-run sustainability of budget deficits, when fiscal policy is conducted as a non-linear process. Our empirical methodology makes use of recent developments on threshold cointegration that consider the possibility of a non-linear relationship between government expenditures and revenues. The analysis is applied to the case of Spain, a country that has recently accomplished an important fiscal consolidation. Overall, our results suggest the presence of significant non-linear effects in Spanish fiscal policy, so that fiscal authorities would cut deficits only if they are ‘large’, which would assure in turn their long-run sustainability.