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Predicting Sovereign Fiscal Crises: High-Debt Developed Countries

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Abstract

Every country has a fiscal limit on debt, where that limit represents a debt level so high that the country's economic and political systems cannot raise taxes or reduce spending sufficiently to maintain solvency. At the limit, creditors flee, and the government faces a fiscal crisis. If we knew the limit, then we could estimate the probability of a fiscal crisis as the probability of reaching the limit. Governments do not announce their fiscal limits. In this paper, we estimate fiscal feedback rules for six-high-debt developed countries to investigate the extent to which the systematic response of the primary surplus to debt reveals information on the fiscal limit. In general, estimation of a fiscal feedback rule does not reveal an explicit fiscal limit for a country that has not experienced a crisis. However, estimates of long-run debt, together with debt history, can be combined to yield an estimate of a lower bound on the fiscal limit. We use estimates of the fiscal rule for six high-debt developed countries to project debt forward from dates, following the beginning of the financial crisis, and compare the projections with our estimates of the lower bound on debt. We label countries, whose debt projections exceed the lower bound as high-risk. Both Greece and Portugal enter the high-risk category about one year prior to their financial crises. Italy is at high risk in 2012 and others are at low risk through 2012.

Suggested Citation

  • Betty Daniel, Christos Shiamptanis, 2015. "Predicting Sovereign Fiscal Crises: High-Debt Developed Countries," LCERPA Working Papers 0090, Laurier Centre for Economic Research and Policy Analysis, revised 05 May 2015.
  • Handle: RePEc:wlu:lcerpa:0090
    Note: LCERPA Working Paper No. 2015-8, May 2015.
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    References listed on IDEAS

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    Cited by:

    1. Christos Shiamptanis, 2017. "Austerity Measures: Do they avert solvency crises?," LCERPA Working Papers 0103, Laurier Centre for Economic Research and Policy Analysis, revised 19 Jun 2017.
    2. Checherita-Westphal, Cristina & Žďárek, Václav, 2017. "Fiscal reaction function and fiscal fatigue: evidence for the euro area," Working Paper Series 2036, European Central Bank.

    More about this item

    Keywords

    Fiscal Limits; Fiscal Rules; Fiscal Solvency; Fiscal Sustainability; Sovereign Default;

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F5 - International Economics - - International Relations, National Security, and International Political Economy

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