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Fiscal fragility: what the past may say about the future

  • Aizenman, Joshua
  • Pasricha, Gurnain Kaur

The end of the great moderation has profound implications on the assessment of fiscalsustainability. The pertinent issue goes beyond the increase in stock of public debt/GDP inducedby the global recession, to include the perspective that the sustainability of a given publicdebt/GDP depends on the future volatility of the difference between real interest rates and GDPgrowth rate. For a given future projected public debt/GDP, we evaluate the possible distributionof the fiscal burden of debt for each OECD country, based on the historical realizations of thereal interest rate and GDP growth differential. Fiscal projections may be alarmist if one jumpsfrom the prior of low fiscal burdens that prevailed during great moderation to the prior ofpermanent high future burden. Yet, the importance of both real interest rate and the GDP growthrate in determining the actual debt burdens as well as the range of scenarios faced by OECDcountries in the past suggests that countries exposed to heightened vulnerability may considerboth short term stabilization (i.e., fiscal stimulus to support the recovery) and forward lookingfiscal reforms (i.e. fiscal tightening to stabilize the debt dynamics).

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Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt7mf244m2.

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Date of creation: 10 Nov 2010
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Handle: RePEc:cdl:ucscec:qt7mf244m2
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  1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  2. William Easterly & Michael Kremer & Lant Pritchett & Lawrence H. Summers, 1993. "Good Policy or Good Luck? Country Growth Performance and Temporary Shocks," NBER Working Papers 4474, National Bureau of Economic Research, Inc.
  3. Frederic S. Mishkin, 1981. "The Real Interest Rate: An Empirical Investigation," NBER Working Papers 0622, National Bureau of Economic Research, Inc.
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