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Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies

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  • Atish R. Ghosh
  • Jun I. Kim
  • Enrique G. Mendoza
  • Jonathan D. Ostry
  • Mahvash S. Qureshi

Abstract

How high can public debt rise without compromising fiscal solvency? We answer this question using a stochastic ability-to-pay model of sovereign default in which risk-neutral investors lend to a government that displays “fiscal fatigue,” because its ability to increase primary balances cannot keep pace with rising debt. As a result, the government faces an endogenous debt limit beyond which debt cannot be rolled-over. Using data for 23 advanced economies over 1970–2007, we find evidence of a fiscal reaction function with these features, and use it to compute “fiscal space,” defined as the difference between projected debt ratios and debt limits.

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Bibliographic Info

Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): (2013)
Issue (Month): (02)
Pages: F4-F30

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Handle: RePEc:ecj:econjl:v::y:2013:i::p:f4-f30

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  1. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates and the current account," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  2. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
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