OECD Economics Department Working Papers

ISSN :
1815-1973 (online)
DOI :
10.1787/18151973
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Working papers from the Economics Department of the OECD that cover the full range of the Department’s work including the economic situation, policy analysis and projections; fiscal policy, public expenditure and taxation; and structural issues including ageing, growth and productivity, migration, environment, human capital, housing, trade and investment, labour markets, regulatory reform, competition, health, and other issues.
 

Avoiding Debt Traps

Financial Backstops and Structural Reforms You or your institution have access to this content

Authors:
Pier Carlo Padoan1, Urban Sila1, Paul van den Noord
Author Affiliations
  • 1: OECD, France

Publication Date
29 June 2012
Bibliographic information
No.:
976
Pages
31
DOI
10.1787/5k962hhtt5mr-en

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In this paper we develop a simple analytical framework to analyze "good" and "bad equilibria" in public-debt and growth dynamics. The "bad equilibrium" is characterised by the simultaneous occurrence, and adverse feedbacks between, high and growing fiscal deficits and debt, high risk premia on sovereign debt, slumping economic activity and plummeting confidence, whereas a "good equilibrium" is characterized by stable growth and debt and low risk premia. We use this framework to identify – both theoretically and empirically – the good and bad equilibrium levels of debt and policies that can help a country caught in a bad equilibrium to recover. The analysis shows that despite some output loss in the short run fiscal consolidation can help countries escape from the bad equilibrium trap. More broadly, we find that a combination of financial backstops, structural reform and fiscal consolidation is most effective in helping countries getting onto a sustainable path.
Keywords:
sovereign debt, fiscal policy, multiple equilibria
JEL Classification:
  • C33: Mathematical and Quantitative Methods / Multiple or Simultaneous Equation Models; Multiple Variables / Models with Panel Data; Longitudinal Data; Spatial Time Series
  • C62: Mathematical and Quantitative Methods / Mathematical Methods; Programming Models; Mathematical and Simulation Modeling / Existence and Stability Conditions of Equilibrium
  • E62: Macroeconomics and Monetary Economics / Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook / Fiscal Policy