What is a Sustainable Public Debt?

78 Pages Posted: 21 Sep 2015

See all articles by Pablo D'Erasmo

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Enrique G. Mendoza

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

Jing Zhang

University of Michigan at Ann Arbor

Date Written: September 2015

Abstract

The question of what is a sustainable public debt is paramount in the macroeconomic analysis of fiscal policy. This question is usually posed 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.

Suggested Citation

D'Erasmo, Pablo and Mendoza, Enrique G. and Zhang, Jing, What is a Sustainable Public Debt? (September 2015). NBER Working Paper No. w21574. Available at SSRN: https://ssrn.com/abstract=2663232

Pablo D'Erasmo (Contact Author)

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

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Enrique G. Mendoza

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

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

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