Working Paper: CEPR ID: DP15478
Authors: Sweder van Wijnbergen; Stan Olijslager; Nander de Vette
Abstract: Interest rates on public debt have for several years now fallen short of GDP growth rates in much of the Western world. In his presidential address to the AEA Blanchard argued that this implies that there are no fiscal costs to high debt (Blanchard, 2019).He did outline other reasons not to run large deficits in his address.} In this paper we argue that the safe rate is not the right interest rate to use for that comparison. We develop a General Equilibrium Asset Pricing model and econometrically estimate the relevant characteristics of the stochastic processes driving the primary surplus in relation to the growth rate of aggregate consumption and derive the proper risk premium. The resulting interest rate exceeds the growth rate. We then calculate the discounted value of future primary surpluses using the same stochastic process for the primary surplus and compare that to the market value of the (Dutch) public sector debt. We test various explanations for the gap between these two and derive the fiscal adjustment necessary to eliminate it (the ``fiscal sustainability gap").
Keywords: debt; valuation; sustainable deficits; fiscal adjustment gap
JEL Codes: G12; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| primary surpluses (H62) | GDP growth rates (O47) |
| risk-adjusted interest rate (E43) | fiscal sustainability gap (E62) |
| public primary surpluses are stochastic (H62) | risk-adjusted rate should be used for discounting (H43) |
| risk-adjusted interest rate > GDP growth rate (E43) | fiscal sustainability gap (E62) |
| lower interest rates on public debt (r < g) (H63) | perception of no fiscal costs associated with high debt levels (H69) |
| public primary surpluses deterministic/unrelated to consumption growth (H62) | perception of no fiscal costs is valid (H69) |
| discounted value of future primary surpluses < market value of public sector debt (H68) | fiscal sustainability gap (E62) |