The Global Dimension to Fiscal Sustainability Joseph P. Byrne, Norbert Fiess * and Ronald MacDonald Department of Economics, University of Glasgow, Glasgow, Scotland, UK 31 st March 2008 Abstract This paper examines the issue of fiscal sustainability in emerging market countries and industrial countries. We highlight the importance of the time series properties of the primary surplus and debt, and find evidence of a positive long run relationship. Consequently we emphasise, that especially for emerging markets, it is important to recognise the implications of global capital market shocks for fiscal sustainability, a relationship which has hitherto been ignored in the empirical literature. Using a factor model we demonstrate that the relationship between deficit and debt is conditional upon a global factor and we suggest that this global factor is related to world-wide liquidity. We also demonstrate that this acts as a constraint on emerging market economies’ fiscal policy. Keywords: Fiscal Policy; Sustainability. JEL Codes: E62; F34; H62; H63. * Correspondence Address: University of Glasgow, Department of Economics, Adam Smith Building, Glasgow, G12 8RT, United Kingdom. Email: <n.fiess@lbss.gla.ac.uk>. Tel: +44(0)141 330 5683. Fax: +44 (0)141 330 4940. For their comments and other discussions the authors would like to thank without implicating seminar participants at the World Bank, Washington and SIRE Conference on Economic and Financial Linkages in the University of Glasgow. In particular, Marco Bassi, Aleksander Berensten, Nina Budina, Giorgio Fazio, David Hendry, Søren Johansen, Alexandros Kontonikas, Farhad Noorbakhash and Brian Pinto.