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Avoiding Debt Traps: Financial Backstops and Structural Reforms

Author

Listed:
  • Pier Carlo Padoan

    (OECD)

  • Urban Sila

    (OECD)

  • Paul van den Noord

    (OECD)

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.

Suggested Citation

  • Pier Carlo Padoan & Urban Sila & Paul van den Noord, 2012. "Avoiding Debt Traps: Financial Backstops and Structural Reforms," OECD Economics Department Working Papers 976, OECD Publishing.
  • Handle: RePEc:oec:ecoaaa:976-en
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    File URL: http://dx.doi.org/10.1787/5k962hhtt5mr-en
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    References listed on IDEAS

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    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "The Aftermath of Financial Crises," American Economic Review, American Economic Association, vol. 99(2), pages 466-472, May.
    2. 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.
    3. 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.
    4. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "Growth in a Time of Debt," American Economic Review, American Economic Association, vol. 100(2), pages 573-578, May.
    5. 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.
    6. 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, June.
    7. Tenhofen Jörn & Wolff Guntram B. & Heppke-Falk Kirsten H., 2010. "The Macroeconomic Effects of Exogenous Fiscal Policy Shocks in Germany: A Disaggregated SVAR Analysis," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 230(3), pages 328-355, June.
    8. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises; A New Database," IMF Working Papers 08/224, International Monetary Fund.
    9. 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.
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    Citations

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    Cited by:

    1. Adler, Gustavo & Lizarazo, Sandra, 2015. "Intertwined sovereign and bank solvencies in a simple model of self-fulfilling crisis," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 428-448.
    2. Thomas Warmedinger & Cristina Checherita-Westphal & Pablo Hernández de Cos, 2015. "Fiscal Multipliers and Beyond," Hacienda Pública Española, IEF, vol. 215(4), pages 139-168, December.
    3. Dieppe, Alistair & Mourinho Félix, Ricardo & Marchiori, Luca & Grech, Owen & Albani, Maria & Other contributors & Kulikov, Dmitry & Papadopoulou, Niki & Sideris, Dimitris & Irac, Delphine & Gordo Mora, 2015. "Public debt, population ageing and medium-term growth," Occasional Paper Series 165, European Central Bank.
    4. Ugo Panizza & Andrea F. Presbitero, 2013. "Public Debt and Economic Growth in Advanced Economies: A Survey," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 149(II), pages 175-204, June.
    5. 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.
    6. Balázs Égert, 2015. "The 90% public debt threshold: the rise and fall of a stylized fact," Applied Economics, Taylor & Francis Journals, vol. 47(34-35), pages 3756-3770, July.
    7. 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 403-403, February.
    8. Balázs Égert, 2015. "Public debt, economic growth and nonlinear effects: Myth or reality?," Journal of Macroeconomics, Elsevier, vol. 43(C), pages 226-238.
    9. repec:ecb:ecbops:2011162 is not listed on IDEAS
    10. Kudrin, A. & Gurvich, E., 2015. "Government Stimulus or Economic Incentives?," Journal of the New Economic Association, New Economic Association, vol. 26(2), pages 179-186.
    11. Nikolaos Antonakakis, 2014. "Sovereign Debt and Economic Growth Revisited: The Role of (Non-)Sustainable Debt Thresholds," Department of Economics Working Papers wuwp187, Vienna University of Economics and Business, Department of Economics.
    12. Castro, Gabriela & Félix, Ricardo M. & Júlio, Paulo & Maria, José R., 2015. "Unpleasant debt dynamics: Can fiscal consolidations raise debt ratios?," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 276-294.
    13. Mencinger, Jernej & Verbic, Miroslav & Aristovnik, Aleksander, 2015. "Revisiting the role of public debt in economic growth: The case of OECD countries," MPRA Paper 67704, University Library of Munich, Germany.
    14. Jasper Lukkezen & Hugo Rojas-Romagosa, 2013. "Stochastic debt sustainability indicators," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 97-121.
    15. repec:ecb:ecbops:2014165 is not listed on IDEAS
    16. John Farrugia & Owen, Grech, 2013. "Assessing the sustainability of Maltese government debt," CBM Working Papers WP/04/2013, Central Bank of Malta.

    More about this item

    Keywords

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

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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