Fiscal rules for debt sustainability in emerging markets: the impact of volatility and default risk
AbstractThe determinants of public debt dynamics – real interest rates, the real exchange rate, output growth and the primary fiscal balance – are typically more volatile in emerging market economies than in industrialised countries. Capital markets also typically demand higher interest rates from emerging markets when their debt dynamics deteriorate. This paper considers how these characteristics affect the choice of fiscal policy rules in emerging markets. We estimate an econometric model of the determinants of public debt dynamics on Brazilian data and use this model to simulate the effect of different fiscal policy rules for future paths of debt. We then derive the set of fiscal policy rules which stabilise public debt dynamics. We find that macroeconomic forecast uncertainty and feedback among the endogenous variables (principally from the debt-GDP ratio to interest rates) force the policy rule to be significantly more responsive to changes in public debt. Rules that would stabilise debt in a fully known world may not do so when the policymaker is faced with a realistic pattern of shocks. The method we employ may be a useful addition to the toolkit of domestic and international policymakers when assessing fiscal rules and debt sustainability.
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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 307.
Date of creation: Sep 2006
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-12-01 (All new papers)
- NEP-CBA-2006-12-01 (Central Banking)
- NEP-CFN-2006-12-01 (Corporate Finance)
- NEP-MAC-2006-12-01 (Macroeconomics)
- NEP-PBE-2006-12-01 (Public Economics)
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