1887

OECD Economics Department Working Papers

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.

English, French

Limits to government debt sustainability

The recent euro area sovereign debt crisis has shown the importance of market reactions for the sustainability of debt. The objective of this paper is to calculate endogenous government debt limits given the markets assessment of the probability to default. The estimated primary balance reaction function to growing debt has the “fiscal fatigue” property (a loosening fiscal effort makes the primary balance insufficient to support rising debt) at high debt levels. It is the combination of this feature of the primary balance reaction function with the market interest rate reaction to growing debt that determines the government debt limit beyond which debt cannot be rolled over. An application of this framework to OECD countries over the period 1985 – 2013 shows that current debt limits are high for most of the OECD thanks to particularly low current interest rates. It shows also for some countries that current debt levels are not sustainable without a change in government behaviour as compared to the past. Most importantly, the framework illustrates the state contingent nature of debt limits and therefore the vulnerability of governments to a change in macroeconomic conditions and to market reactions.

English

Keywords: debt, sustainability, fiscal policy
JEL: E44: Macroeconomics and Monetary Economics / Money and Interest Rates / Financial Markets and the Macroeconomy; H63: Public Economics / National Budget, Deficit, and Debt / National Debt; Debt Management; Sovereign Debt; E62: Macroeconomics and Monetary Economics / Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook / Fiscal Policy; H68: Public Economics / National Budget, Deficit, and Debt / Forecasts of Budgets, Deficits, and Debt; E27: Macroeconomics and Monetary Economics / Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy / Macroeconomics: Consumption, Saving, Production, Employment, and Investment: Forecasting and Simulation: Models and Applications; H62: Public Economics / National Budget, Deficit, and Debt / National Deficit; Surplus; E61: Macroeconomics and Monetary Economics / Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook / Policy Objectives; Policy Designs and Consistency; Policy Coordination
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