Working Paper: CEPR ID: DP15282
Authors: Dmitriy Sergeyev; Neil Mehrotra
Abstract: Conditions of secular stagnation—low output growth g and low interest rates r—havecounteracting effects on the cost of servicing public debt, r − g. Using data for ad-vanced economies, we document that r is often less than g, but r − g exhibits substan-tial variability over the medium-term. We build a continuous-time model in whichthe debt-to-GDP ratio is stochastic and r < g on average. We analytically characterizethe distribution of the debt-to-GDP ratio, showing how two candidate explanationsfor low interest rates, slower trend growth and higher output risk, can lower the debt-to-GDP ratio. When the primary surplus is bounded above, we characterize a fiscallimit, above which default occurs, and a debt tipping point, above which the pub-lic debt is on an unsustainable path, but default does not occur immediately. Slowertrend growth and higher output risk can paradoxically improve debt sustainability. Aconservative calibration suggests a fiscal limit for the US of 184 percent of GDP and atipping point of 115 percent of GDP.
Keywords: Secular Stagnation; Public Debt; Debt Sustainability; Low Interest Rates; Government Default
JEL Codes: E43; E62; H68
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low interest rates (r) (E43) | sustainable public debt (H63) |
| slow growth (g) (O40) | sustainable public debt (H63) |
| slower trend growth and higher output risk (F62) | improved debt sustainability (H63) |
| lower growth (O40) | lower real interest rates (r) (E43) |
| fiscal limit (184% of GDP) (H69) | sustainability of public debt (H63) |
| tipping point (115% of GDP) (F62) | unsustainable debt dynamics (H63) |