CEIS Centre for Economic and International TOR VERGATA Studies CEiS Tor Vergata RESEARCH PAPER SERIES Vol.10, lssue 11, No.248 - July 2012 Fiscal Policy and Public Debt Dynamics in Italy, 1861-2009 AlessandroPiergallini and Michele Postigliola This paper can be downloaded without charge from the SocialScience ResearchNetworkElectronicPaperCollection http://papers.ssrn.com/paper.taf?abstract_id=2118748 Electronic copy available at: http:/ssrn.com/abstract=2118748 Electronic copyavailable at: http://ssrn.com/abstract=2118748 Fiscal Policy and Public Debt Dynamics in Italy, 1861-2009* Alessandro Piergallinit and Michele Postigliola University of Rome “"Tor Vergata" July 18, 2012 Abstract We examine the historical dynamics of government debt in post-unification Italy, from 1861 to 2009. Unit root tests for the debt-GDP ratio are unable to reject either the non-stationarity or the stationarity null hypothesis. Controlling debt dynamics for fiscal feedback policies of the Barro-Bohn style, however, the debt-GDP ratio is found to be mean-reverting. Mean-reversion in the debt-GDP ratio is due not only to a nominal growth dividend, but also to a positive response of primary surpluses to variations in outstanding debt. There is indeed significant evidence that, over the history of Italy, fiscal policy makers have reacted to the accumulation of debt, taking corrective measures to rule out potential long-term sustainability problems. JELClassification:E62;H60;C20. Keywords: Fiscal Policy; Public Debt; Fiscal Sustainability. *We thank an anonymous referee, Marianna Belloc, Efrem Castelnuovo, Claudio De Vincenti, Michele Fratianni, Giampiero M. Gallo, Barbara Guardabascio, Marco Lippi, Tommaso Proietti, Giorgio Rodano, Mauro Rota, Pasquale L. Scandizzo, Robert Waldmann, and participants in seminars at the Department of Public Economics, University of Rome"La Sapienza", at the Department of Economics, University of Rome"Tor Vergata", at the Scottish Economic Society 2011 Annual Conference in Perth and at the Italian Economic Association 2011 Annual Conference, Roma Tre University, for very helpful comments and suggestions. The usual disclaimer applies. The data employed in the paper are specified in the Appendix. Department of Economics,University of Rome"Tor Vergata",Via Columbia 2,00133Roma, Italy E-mail: [email protected]: +390672595431.Fax: +39062020500. Department of Economics, University of Rome"Tor Vergata",Via Columbia 2, 00133Roma,Italy E-mail: [email protected]. Electronic copyavailable at:http://ssrn.com/abstract=2118748 "Now I believe that one really imposes burdens on tarpayers not when one votes tares, but when one votes erpenditures" Quintino Sella,FinanceMinister (Italian House of Representatives,December11,1872) 1 Introduction Italy's nominal public debt is the third largest in the world after the United States and Japan.1 Italy's public debt-GDP ratio is the eleventh largest in the world after Liberia Japan, St. Kitts and Nevis, Guinea-Bissau, Lebanon, the Democratic Republic of Congo, Jamaica, Seychelles, Grenada, and Antigua and Barbuda.2 Debt and deficits in Italy have sharply increased following the Great Recession started in 2007. The sustainability of Italian fiscal policy has thus turned to be a critical issue. In current public policy debates, it is often argued that the European debt crisis erupted in 2009-2010 in Greece and Ireland could generate contagion and moral hazard problems in other Euro Area Member States, notably Portugal, Spain, and Italy. Did Italy's fiscal policy makers react to debt accumulation in the past? Is Italy's public debt on a sustainable path? In this paper we examine the historical dynamics of government debt in post-unification Italy, from 1861 to 2009. In 1861, the first Finance Minister of the Kingdom of Italy, Pietro Bastogi, set up the Gran Libro del Debito Pubblico Italiano to incorporate the debts of all the existent States before unification. Th