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Stochastic debt sustainability indicators

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  • Jasper Lukkezen
  • Hugo Rojas-Romagosa

Abstract

This paper proposes indicators to assess government debt sustainability in the medium and long term. We follow the methodological approach by Bohn (2008) and distinguish three channels that contribute to sustainable government finances: economic growth, real interest payments and fiscal responses. We combine the estimated fiscal response with a stochastic debt simulation to create two indicators. The first captures the probability of debt-to-GDP ratios rising by more than 20 percentage points during a 10-year period. A government will fail on this indicator if its fiscal response to an increase in debt is not sufficient to control the swings in debt caused by shocks to real growth and interest payments. The second indicator captures the probability of debt levels being above 90% of GDP in 10 years. We estimate these indicators using historical data for nine OECD countries. We find that the probability of debt-to-GDP ratios rising by more than 20 percentage points in the next decade clearly identifies countries that have sustainability concerns: Italy, Spain, Portugal and Iceland, from those that do not: US, UK, Netherlands, Belgium and Germany. JEL Classification: E4, E6, H0, H6

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Bibliographic Info

Article provided by Presses de Sciences-Po in its journal Revue de l'OFCE.

Volume (Year): N° 127 (2013)
Issue (Month): 1 ()
Pages: 97-121

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Handle: RePEc:cai:reofsp:reof_127_0097

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Web page: http://www.cairn.info/revue-de-l-ofce.htm

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Keywords: fiscal policy; public debt; sustainability;

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  1. Reinhart, Carmen & Rogoff, Kenneth, 2010. "Growth in a Time of Debt," CEPR Discussion Papers 7661, C.E.P.R. Discussion Papers.
  2. Davide Furceri & Aleksandra Zdzienicka, 2011. "How Costly Are Debt Crises?," IMF Working Papers 11/280, International Monetary Fund.
  3. Checherita-Westphal, Cristina & Rother, Philipp, 2012. "The impact of high government debt on economic growth and its channels: An empirical investigation for the euro area," European Economic Review, Elsevier, vol. 56(7), pages 1392-1405.
  4. Carmen M. & M. Belen Sbrancia, 2011. "The Liquidation of Government Debt," Working Paper Series WP11-10, Peterson Institute for International Economics.
  5. Martin Larch & Matteo Salto, 2005. "Fiscal rules, inertia and discretionary fiscal policy," Applied Economics, Taylor & Francis Journals, vol. 37(10), pages 1135-1146.
  6. Lejour, Arjan & Lukkezen, Jasper & Veenendaal, Paul, 2010. "Sustainability of Government Debt in the EU," MPRA Paper 30139, University Library of Munich, Germany, revised 07 Jun 2010.
  7. Cooper, Russell & Kempf, Hubert & Peled, Dan, 2010. "Regional debt in monetary unions: Is it inflationary?," European Economic Review, Elsevier, vol. 54(3), pages 345-358, April.
  8. De Grauwe, Paul, 2011. "Governance of a Fragile Eurozone," CEPS Papers 5523, Centre for European Policy Studies.
  9. Adi Brender & Allan Drazen, 2008. "How Do Budget Deficits and Economic Growth Affect Reelection Prospects? Evidence from a Large Panel of Countries," American Economic Review, American Economic Association, vol. 98(5), pages 2203-20, December.
  10. Reinhart, Carmen M. & Rogoff, Kenneth S., 2010. "Growth in a Time of Debt," Scholarly Articles 11129154, Harvard University Department of Economics.
  11. Jasper Lukkezen & Hugo Rojas-Romagosa, 2012. "When is debt sustainable?," CPB Discussion Paper 212, CPB Netherlands Bureau for Economic Policy Analysis.
  12. Pier Carlo Padoan & Urban Sila & Paul van den Noord, 2012. "Avoiding Debt Traps: Financial Backstops and Structural Reforms," OECD Economics Department Working Papers 976, OECD Publishing.
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