Working Paper: NBER ID: w19297
Authors: David Greenlaw; James D. Hamilton; Peter Hooper; Frederic S. Mishkin
Abstract: Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders lead to higher sovereign interest rates which in turn make the debt problems more severe. We analyze the recent experience of advanced economies using both econometric methods and case studies and conclude that countries with debt above 80% of GDP and persistent current-account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping-point dynamics. Such feedback is left out of current long-term U.S. budget projections and could make it much more difficult for the U.S. to maintain a sustainable budget course. A potential fiscal crunch also puts fundamental limits on what monetary policy is able to achieve. In simulations of the Federal Reserve's balance sheet, we find that under our baseline assumptions, in 2017-18 the Fed will be running sizable income losses on its portfolio net of operating and other expenses and therefore for a time will be unable to make remittances to the U.S. Treasury. Under alternative scenarios that allow for an emergence of fiscal concerns, the Fed's net losses would be more substantial.
Keywords: Fiscal Crises; Monetary Policy; Sovereign Debt; Interest Rates
JEL Codes: E63; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Debt levels (H63) | Fiscal crunch (E62) |
| Sovereign interest rates (E43) | Debt problems (F34) |
| Debt levels and current account deficits (F32) | Vulnerability to fiscal deterioration (H68) |
| Debt levels (H63) | Borrowing costs (G32) |
| Debt levels (H63) | Yield on 10-year government bonds (E43) |
| Debt levels (H63) | Nonlinear relationship with interest rates (E43) |