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Fiscal sustainability using growth-maximizing debt targets

Author

Listed:
  • Cristina Checherita-Westphal
  • Andrew Hughes Hallett
  • Philipp Rother

Abstract

This article highlights the importance of debt-related fiscal rules and derives growth-maximizing public debt ratios from a simple theoretical model. On the basis of evidence on the productivity of public capital, we estimate public debt targets that governments should maintain if they wish to maximize growth for panels of OECD, EU and euro area countries. These are not arbitrary numbers, but are founded on long-run optimizing behaviour assuming that governments implement the golden rule of financing; that is, they contract debt only to finance public investment. Our estimates suggest that the euro area should target debt levels of around 50% of GDP if member states are to have common targets. That is about 15% points lower than the estimate for the growth-maximizing debt ratio in our OECD sample and comfortably within the Stability and Growth Pact's debt ceiling of 60% of GDP. We also indicate how forward-looking budget reaction functions fit into a debt targeting framework.

Suggested Citation

  • Cristina Checherita-Westphal & Andrew Hughes Hallett & Philipp Rother, 2014. "Fiscal sustainability using growth-maximizing debt targets," Applied Economics, Taylor & Francis Journals, vol. 46(6), pages 638-647, February.
    • Handle: RePEc:taf:applec:v:46:y:2014:i:6:p:638-647
    DOI: 10.1080/00036846.2013.861590
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    More about this item

    JEL classification:

    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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