Working Paper: NBER ID: w16782
Authors: Atish R. Ghosh; Jun I. Kim; Enrique G. Mendoza; Jonathan D. Ostry; Mahvash S. Qureshi
Abstract: How high can public debt rise without compromising fiscal solvency? We answer this question using a stochastic ability-to-pay model of sovereign default in which risk-neutral investors lend to a government that displays "fiscal fatigue," because its ability to increase primary balances cannot keep pace with rising debt. As a result, the government faces an endogenous debt limit beyond which debt cannot be rolled-over. Using data for 23 advanced economies over 1970-2007, we find evidence of a fiscal reaction function with these features, and use it to compute "fiscal space," defined as the difference between projected debt ratios and debt limits.
Keywords: Fiscal fatigue; Fiscal space; Debt sustainability
JEL Codes: E62; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| public debt (H63) | primary balance (F32) |
| public debt (H63) | primary balance response (F32) |
| higher probability of default (G33) | widening risk premium (G19) |
| widening risk premium (G19) | increased debt service burden (F34) |
| increased debt service burden (F34) | higher probability of default (G33) |
| rising debt (H63) | probability of default (G33) |
| debt exceeds threshold (H63) | inevitable default (G33) |
| low debt levels (H63) | primary balance (F32) |