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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.
The views expressed in these papers are those of the author(s) and do not necessarily reflect those of the OECD or of the governments of its member countries.
Avoiding Debt Traps
Financial Backstops and Structural Reforms
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- Pier Carlo Padoan1, Urban Sila1, Paul van den Noord
- Author Affiliations
- 1: OECD, France
- 29 juin 2012
- Bibliographic information
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.
- sovereign debt, fiscal policy, multiple equilibria
- Classification JEL:
- C33: Mathematical and Quantitative Methods / Multiple or Simultaneous Equation Models; Multiple Variables / Panel Data Models; Spatio-temporal Models
- 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