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Assessing Debt Sustainability in a Stochastic Environment: 200 years of Dutch Debt and Deficit Management

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  • Sweder van Wijnbergen

    (University of Amsterdam)

  • Alexander France

    (University of Amsterdam)

Abstract

When debt levels approach critical levels, tax payers may revolt against the associated debtservice burden. Funding problems may arise in capital markets when lenders anticipate such revolts and refuse to participate in debt auctions. We provide a stochastic framework to assess whether such problems may arise and argue that the key to fiscal sustainability in a stochastic environment is a feedback rule from debt level shocks back to corresponding adjustments in the primary surplus. We show that such feedback rules narrow future distributions of debt-output ratios and so reduce crisis probabilities. We apply the methodology to Dutch debt and deficit data spanning two centuries. Our results strongly argue for the incorporation of rules stipulating tightening fiscal policy whenever debt stocks exceed previously agreed upon targets (like in the original Eurozone Stability pact).

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 12-011/2.

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Date of creation: 12 Feb 2012
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Handle: RePEc:dgr:uvatin:20120011

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Web page: http://www.tinbergen.nl

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Keywords: deficits; debt sustainability; fiscal rules;

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  1. Todd Walker & Eric Leeper & Troy Davig, 2010. "Inflation and the Fiscal Limit," 2010 Meeting Papers 837, Society for Economic Dynamics.
  2. Trehan, Bharat & Walsh, Carl E, 1991. "Testing Intertemporal Budget Constraints: Theory and Applications to U.S. Federal Budget and Current Account Deficits," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 206-23, May.
  3. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," NBER Working Papers 9908, National Bureau of Economic Research, Inc.
    • Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany.
  4. Bohn, Henning, 2007. "Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint?," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1837-1847, October.
  5. Andreas Schabert & Sweder van Wijnbergen, 2006. "Debt, Deficits, and Destabilizing Monetary Policy in Open Economies," Tinbergen Institute Discussion Papers 06-045/2, Tinbergen Institute.
  6. Andreas Schabert & Sweder J.G. van Wijnbergen, 2011. "Sovereign Default and the Stability of Inflation Targeting Regimes," Tinbergen Institute Discussion Papers 11-064/2/ DSF20, Tinbergen Institute.
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