Working Paper: CEPR ID: DP16817
Authors: Tim Willems; Jeromin Zettelmeyer
Abstract: This paper surveys the literature on sovereign debt sustainability from its origins in the mid-1980s to the present, focusing on four debates. First, the shift from an “accounting based” view of debt sustainability, evaluated using government borrowing rates, to a “model based” view which uses stochastic discount rates. Second, empirical tests focusing on the relationship between primary balances to debt. Third, debt sustainability in the presence of rollover risk. And fourth, whether government borrowing costs below rates of growth (“r < g”) generate a “free lunch” in the sense that debt sustainability does not require future primary surpluses. We argue that liquidity services provided by sovereign debt may indeed lead to a “free lunch”, albeit of limited size. The value of such services depends on the credibility of the central bank, which can be accumulated via prudent policies and subsequently drawn on to allow for looser fiscal policy.
Keywords: sovereign debt; debt sustainability; fiscal policy; debt crises; fiscal-monetary interactions; central bank credibility
JEL Codes: E52; E58; E62; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sovereign debt sustainability (H63) | fiscal policy (E62) |
| liquidity services provided by sovereign debt (F34) | 'free lunch' effect (H40) |
| credibility of the central bank (E58) | boundary of sustainable debt (F34) |
| rollover risk (G11) | debt sustainability (H63) |
| central bank credibility (E58) | rollover risk (G11) |
| government borrowing costs (H74) | perceptions of debt sustainability (F34) |
| growth rates (r < g) (O40) | perceptions of debt sustainability (F34) |