What is a Sustainable Public Debt?

78 Pages Posted: 15 Sep 2015

See all articles by Pablo D'Erasmo

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia; University of Maryland - College Park

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Jing Zhang

Federal Reserve Bank of Chicago

Date Written: April 16, 2015


The question of what is a sustainable public debt is paramount in the macroeconomic analysis of fiscal policy. This question is usually formulated as asking whether the outstanding public debt and its projected path are consistent with those of the government's revenues and expenditures (i.e. whether fiscal solvency conditions hold). We identify critical flaws in the traditional approach to evaluate debt sustainability, and examine three alternative approaches that provide useful econometric and model-simulation tools to analyze debt sustainability. The first approach is Bohn's non-structural empirical framework based on a fiscal reaction function that characterizes the dynamics of sustainable debt and primary balances. The second is a structural approach based on a calibrated dynamic general equilibrium framework with a fully specified fiscal sector, which we use to quantify the positive and normative effects of fiscal policies aimed at restoring fiscal solvency in response to changes in debt. The third approach deviates from the others in assuming that governments cannot commit to repay their domestic debt, and can thus optimally decide to default even if debt is sustainable in terms of fiscal solvency. We use these three approaches to analyze debt sustainability in the United States and Europe after the recent surge in public debt following the 2008 crisis, and find that all three raise serious questions about the prospects of fiscal adjustment and its consequences in advanced economies.

Keywords: Sustainable debt, Fiscal solvency, Austerity, Sovereign Default, Distortionary taxes

JEL Classification: E6, E62, F4, H6, H87

Suggested Citation

D'Erasmo, Pablo and Mendoza, Enrique G. and Zhang, Jing, What is a Sustainable Public Debt? (April 16, 2015). PIER Working Paper No. 15-033, Available at SSRN: https://ssrn.com/abstract=2660332 or http://dx.doi.org/10.2139/ssrn.2660332

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

University of Maryland - College Park ( email )

College Park, MD 20742
United States

Enrique G. Mendoza (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

Jing Zhang

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

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