Public debt frontiers: The Greek case

This paper attempts to quantify the maximum amount of debt that a government can sustain by itself. Using a Dynamic General Equilibrium model where the government is fully characterized, we compute the steady state inverse relationship between the public debt to output ratio and the size of the government, measured as the total public expenditures to output ratio. This line, called the debt frontier, divides the debt/output, expenditure/output space in two regions: The upper contour set corresponds to debt to output ratios where public debt is long-run unsustainable. Calibration of the model for the Greek economy to ?scal targets reveals that, for the period just before the current recession, i.e. 2002-2006, the debt to GDP ratio was well below the calculated frontier, and that Greek ?scal ?gures where in line with other euro area countries. We conclude that an original ?scal indiscipline did not cause the debt crisis and we have to look for alternative causes such as self-ful?lling crises such as the gambling for redemption hypothesis.