Working Paper: NBER ID: w10637
Authors: Enrique G. Mendoza; P. Marcelo Oviedo
Abstract: Ratios of public debt as a share of GDP in Brazil, Colombia, and Mexico were 10 percentage points higher on average during 1996-2002 than in the period 1990-1995. Costa Rica's debt ratio remained stable but at a high level near 50 percent. Is there reason to be concerned for the solvency of the public sector in these economies? We provide an answer to this question based on the quantitative predictions of a variant of the framework proposed by Mendoza and Oviedo (2004). This methodology yields forward-looking estimates of debt ratios consistent with fiscal solvency for a government that faces revenue uncertainty and can issue only non-state-contingent debt. In this environment, aversion to a collapse in outlays leads the government to respect a "natural debt limit" equal to the annuity value of the primary balance in a "fiscal crisis". A fiscl crisis occurs after a long sequence of adverse revenue shocks and public outlays adjust to a tolerable minimum. The debt limit also represents a credible commitment to be able to repay even in a fiscal crisis but is not, in general, the same as the sustainable debt, which is driven by the probabilistic dynamics of the primary balance. The results of a baseline scenario question the sustainability of current debt ratios in Brazil and Colombia, while those in Costa Rica and Mexico seem inside the limits consistent with fiscal solvency. In contrast, public debt ratios are found to be unsustainable in all four countries for plausible changes to lower average growth rates or higher real interest rates. Moreover, sustainable debt ratios fall sharply when default risk is taken into account.
Keywords: No keywords provided
JEL Codes: F0; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Current debt ratios in Brazil and Colombia (F34) | Near natural debt limits consistent with fiscal solvency (H63) |
| Perceived commitments to reduce non-interest outlays significantly during a fiscal crisis (E62) | Current debt ratios in Brazil and Colombia (F34) |
| Adjustments in public outlays (H59) | Fiscal crisis (H12) |
| Fiscal crisis (H12) | Unsustainable current debt ratios (F34) |
| Reduced growth rates or increased real interest rates (E43) | Sustainability of debt ratios across all four countries (F34) |
| Blanchard ratios (C59) | Misleading conclusions regarding sustainability for Brazil and Colombia (Q37) |