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Avoiding Debt Traps: Financial Backstops and Structural Reforms

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  • Pier Carlo Padoan
  • Urban Sila
  • Paul van den Noord

Abstract

In this paper we develop a simple analytical framework to analyze “good” and “bad equilibria” in public-debt and growth dynamics. The “bad equilibrium” is characterised by the simultaneous occurrence, and adverse feedbacks between, high and growing fiscal deficits and debt, high risk premia on sovereign debt, slumping economic activity and plummeting confidence, whereas a “good equilibrium” is characterized by stable growth and debt and low risk premia. We use this framework to identify – both theoretically and empirically – the good and bad equilibrium levels of debt and policies that can help a country caught in a bad equilibrium to recover. The analysis shows that despite some output loss in the short run fiscal consolidation can help countries escape from the bad equilibrium trap. More broadly, we find that a combination of financial backstops, structural reform and fiscal consolidation is most effective in helping countries getting onto a sustainable path. Éviter les pièges de l'endettement : Assistance financière et réformes structurelles Dans ce document, nous élaborons un cadre d'analyse simple pour étudier les situations de « bon équilibre » et de « mauvais équilibre » dans le contexte de la dynamique de la dette publique et de la croissance. Un « mauvais équilibre » se caractérise par la conjonction des éléments suivants, et l'existence d'effets de rétroaction négatifs entre eux : un déficit budgétaire et une dette volumineux et croissants, des primes de risque élevées sur la dette souveraine, une chute de l'activité économique et un effondrement de la confiance. Inversement, un « bon équilibre » se caractérise par une croissance et une dette stables, conjuguées à des primes de risque faibles. Nous utilisons ce cadre pour cerner – tant sur le plan théorique qu'empirique – les niveaux d'endettement correspondant à ces situations de bon et de mauvais équilibre, ainsi que les mesures qui peuvent aider un pays ayant basculé dans un mauvais équilibre à redresser la situation. Nos analyses montrent que, malgré des pertes de production à court terme, l'assainissement des finances publiques peut aider les pays pris au piège d'une situation de mauvais équilibre à en sortir. De manière plus générale, nous parvenons à la conclusion que des mécanismes d'assistance financière conjugués à des réformes structurelles et à des mesures d'assainissement budgétaire constituent l'approche la plus efficace pour aider les pays à retrouver une trajectoire viable.

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Bibliographic Info

Paper provided by OECD Publishing in its series OECD Economics Department Working Papers with number 976.

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Date of creation: 29 Jun 2012
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Handle: RePEc:oec:ecoaaa:976-en

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Keywords: fiscal policy; sovereign debt; multiple equilibria; équilibres multiples; dette souveraine; politique budgétaire;

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References

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  1. Matteo Cacciatore & Romain Duval & Giuseppe Fiori, 2012. "Short-Term Gain or Pain? A DSGE Model-Based Analysis of the Short-Term Effects of Structural Reforms in Labour and Product Markets," OECD Economics Department Working Papers 948, OECD Publishing.
  2. Reinhart, Carmen & Rogoff, Kenneth, 2010. "Growth in a Time of Debt," CEPR Discussion Papers 7661, C.E.P.R. Discussion Papers.
  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "The Aftermath of Financial Crises," American Economic Review, American Economic Association, vol. 99(2), pages 466-72, May.
  4. Hansen, Bruce E., 1999. "Threshold effects in non-dynamic panels: Estimation, testing, and inference," Journal of Econometrics, Elsevier, vol. 93(2), pages 345-368, December.
  5. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
  6. Romain Bouis & Romain Duval & Fabrice Murtin, 2011. "The Policy and Institutional Drivers of Economic Growth Across OECD and Non-OECD Economies: New Evidence from Growth Regressions," OECD Economics Department Working Papers 843, OECD Publishing.
  7. Romain Bouis & Romain Duval, 2011. "Raising Potential Growth After the Crisis: A Quantitative Assessment of the Potential Gains from Various Structural Reforms in the OECD Area and Beyond," OECD Economics Department Working Papers 835, OECD Publishing.
  8. Thomas Laubach, 2009. "New Evidence on the Interest Rate Effects of Budget Deficits and Debt," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 858-885, 06.
  9. Reinhart, Carmen M. & Rogoff, Kenneth S., 2010. "Growth in a Time of Debt," Scholarly Articles 11129154, Harvard University Department of Economics.
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Cited by:
  1. Balazs Egert, 2013. "The 90% Public Debt Threshold: The Rise & Fall of a Stylised Fact," William Davidson Institute Working Papers Series wp1048, William Davidson Institute at the University of Michigan.
  2. Balázs Égert, 2013. "The 90% Public Debt Threshold: The Rise and Fall of a Stylised Fact," OECD Economics Department Working Papers 1055, OECD Publishing.
  3. Ugo Panizza & Andrea Filippo Presbitero, 2013. "Public Debt and Economic Growth in Advanced Economies: A Survey," Mo.Fi.R. Working Papers 78, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  4. Jernej Mencinger & Aleksander Aristovnik & Miroslav Verbic, 2014. "The Impact of Growing Public Debt on Economic Growth in the European Union," The AMFITEATRU ECONOMIC journal, Academy of Economic Studies - Bucharest, Romania, vol. 16(35), pages 403, February.
  5. Jasper Lukkezen & Hugo Rojas-Romagosa, 2013. "Stochastic debt sustainability indicators," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 97-121.

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