Identifying Countries at Risk of Fiscal Crisis: High-Debt Developed Countries

How large can debt get before triggering a crisis? Since debt is the expected present value of future primary surpluses, the answer depends on a country’s technical and political ability to raise future primary surpluses. However, countries do not raise the primary surplus to its peak and maintain the peak forever, the assumption implicit in the standard practice of setting maximum debt at the present value of the peak surplus. We estimate fiscal feedback rules for seven high-debt developed countries and find an increase in debt creates a sustained increase in the primary surplus, with the primary surplus reaching a peak in the future. Therefore, our implied debt limit is much lower than the standard measure. We estimate debt limits following the global financial crisis in 2008 and find substantial heterogeneity. We separate countries into risk categories based on fiscal space. Greece and Portugal eroded their fiscal space several years, prior to their fiscal crises, placing them in the highest risk category and predicting the crises that followed. Canada and Belgium maintained large enough fiscal space to achieve safe status. Other countries reduced fiscal space, with France and Spain eroding fiscal space in 2014, warning of future crises.