Fiscal asymmetries and debt crises: Evidence from Lebanon using a sign restricted structural VAR model

Abstract

This study identifies empirically Lebanon's fiscal asymmetries and shocks and traces their effects on GDP using a sign-restricted structural VAR approach. Following Arias et al.’s (2018) identification procedure of sign and zero restrictions, our empirical findings point to a sluggish effect of fiscal policy on economic activity, stipulating that fiscal policy is conducted with non-Keynesian features. The study also documents evidence in favor of crowding out effects given that central government's borrowings are mainly from the local financial market. Moreover, with a non-Keynesian effect of fiscal policy, policy makers should refrain from using fiscal tools to counteract business-cycle fluctuations. It is shown that in order to break through government expenditure's inefficiency, the government must curb a rising budget deficit, which is harnessing an increasing cost of capital and impinging negatively on debt and its service. A rising sovereign debt, in turn, has subsequently triggered a sovereign debt crisis in October 2019.