time varying parameter model

Governments pursue macroeconomic objectives such as stabilizing the economy by employing fiscal policy tools. However, fiscal sustainability is obligatory for achieving economic stability. This research, utilizing linear and nonlinear fiscal reaction functions, including quadratic and cubic, time-varying parameter and Markov-switching fiscal regime change functions, measures the fiscal sustainability of the Iranian government and its determinants in the period 1970-2021. Based on the findings of this research, the government debt-to-GDP ratio in linear and nonlinear models is negative and insignificant, but in the model with control variables, it is negative and strongly significant. Hence, the model with control variables results in the unsustainability of Iran's fiscal policy. The results of Markov-switching fiscal regime change model reveals the existence of two fiscal regimes in Iran's fiscal policy. An unsustainable fiscal regime, in which the reaction of the primary budget balance to the public debt is negative and significant, and a sustainable fiscal regime in which the reaction of the primary budget balance to the public debt is positive but insignificant. Also, the results of the Markov-switching fiscal regime change model demonstrates that the average filtered and smoothed transmission probabilities of remaining in unsustainable fiscal regime is higher than that of sustainable fiscal regime, which indicates that Iran's fiscal policy has been unsustainable. Based on the results of the time-varying parameter model, the reaction of the primary budget balance to the debt expansion has been negative and diminishing, therefore, debt reduction has not been the priority of governments in Iran, and as a result, Iran's fiscal policy has been proceeding in the unsustainable direction.

 A balanced government budget plays a decisive role in the stability of the macroeconomics, and the continuous budget deficit puts the stability of the economy at risk. A budget deficit transpires when the expansion in government expenditures exceeds the growth in government revenue. On the other hand, one of the reasons for the government debt enlargement is the continuous budget deficit. Permanent budget deficit has harmful effects on the economy. Therefore, economists recommend that the government should prevent excessive increase in debt by maintaining a sustainable fiscal policy. Fiscal policy is sustainable when the government reacts to the debt swelling by creating an adequate budget surplus. On the contrary, unsustainable fiscal policy causes crises such as suboptimal allocation of resources, failure in financial markets and high inflation rates. Iran's economy has always been struggling with the permanent budget deficit and high debt stocks. The major motive for this is the dependence of the Iranian government's revenues on the sale of crude oil and its products, because with the decrease in oil revenues, the government resorted to borrowing to compensate for its budget deficit, resulting in debt accretion. Therefore, it is necessary to understand the perspective of fiscal sustainability in Iran. The objective of this research is to assess Iran's government fiscal sustainability and its influential factors by employing annual data of Iran's economy from 1971 to 2022 and by utilizing constant parameter fiscal reaction functions including linear and non-linear models, time-varying parameter fiscal reaction function, Markov-switching fiscal regime change model and fiscal reaction function including control variables.

The existing literature about fiscal sustainability in Iran, has mainly examined fiscal sustainability in the framework of constant parameter linear fiscal reaction function. This research assesses different models of fiscal reaction function, such as constant parameter linear and non-linear models, time-varying parameter models and Markov-switching fiscal regime change models regarding Iran's fiscal sustainability. It also evaluates the dominant variables affecting Iran's fiscal sustainability.

In this research, firstly, the Iran's government fiscal sustainability is tested through the constant parameter linear and non-linear fiscal reaction functions, and to identify the variables affecting fiscal sustainability, the model including control variables is utilized. Then the Markov-switching fiscal regime change model and the time-varying parameter fiscal reaction function are estimated. Among the constant parameter linear and non-linear models, only the linear model including control variables has a significant debt-to-GDP ratio coefficient, which its sign is negative. Hence, it indicates that the fiscal policy implemented in Iran is unsustainable. The Markov-Switching fiscal regime change model shows the existence of two fiscal regimes, one unsustainable fiscal rgime where the reaction of the primary budget balance to public debt is significant and negative and one sustainable fiscal regime where the reaction of the primary budget balance to public debt is insignificant and positive. Also, the results show that the expected duration of the unsustainable fiscal regime is longer than the expected duration of the sustainable fiscal regime. The results of the time-varying parameter model show that the trend of the smoothed changes of the time-varying parameter is downward during the time, therefore, Iran's fiscal policy has proceeded in an unsustainable direction.

The results of the model including the control variables and the time-varying parameter model and the Markov-switching fiscal regime change model show that Iran's fiscal policy is unsustainable. Also, on the basis of this research findings, the variables of the output gap, the government revenue to GDP ratio and exchange rate fluctuation have a positive impact, and the variables of the government real cyclical expenditure and the old population ratio have a negative impact on the fiscal sustainability in Iran. Based on the results of this research, the government debt reduction has not been the priority of the governments in Iran. This has caused unsustainable fiscal policy which in turn, made the Iranian economy more and more vulnerable with regard to external shocks. While developing revenue sources and reducing dependence on oil revenues, the government should reduce its borrowing and therefore decrease the public debt and take steps towards sustainable fiscal policy to help achieving economic stability and sustainable growth in the long-term