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Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies

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

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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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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