Fiscal Sustainability and Its Implication for Fiscal Policy in Korea

A sharp rise in government debt in Korea has followed over years the Asian financial crisis. This paper aims to assess the fiscal performance and test whether the current level of government debt is sustainable for a severely attacked country, namely, Korea. Under the intertemporal budget constraint model, the study tests for fiscal sustainability and examines whether there was any discernible change in the behaviour of government debt following the crisis. It applies the well-known test procedure by Hamilton and Flavin and Trehan and Walsh to the Korean case under study. In a different context, the study also applies the procedure of Campbell and Shiller to the tests of intertemporal budget balance. Their method also allows us to assess whether there was any discernible change in the behavior of government debt following the crisis. This task may not be accomplished with the use of unit roots or cointegration tests because there is only a short sample span since the crisis. The situation is particularly acute for Korea in which only a yearly data are readily available. Empirical analysis indicates that the levels of government debt are not sustainable in Korea. It also shows that the crisis contributes significantly to push the government debt in excess of its sustainable level. This draws a particular policy attention for fiscal consolidation.