A Probabilistic Approach to Fiscal Space and Prudent Debt Level: Application to Low-Income Developing Countries

21 Pages Posted: 9 Dec 2016

See all articles by Olumuyiwa Adedeji

Olumuyiwa Adedeji

International Monetary Fund (IMF)

Calixte Ahokpossi

International Monetary Fund (IMF)

Claudio Battiati

International Monetary Fund (IMF)

Mai Farid

International Monetary Fund (IMF)

Date Written: August 2016

Abstract

What constitutes fiscal space or a prudent level of debt to conduct countercyclical policy while ensuring debt sustainability? This paper addresses the question by exploring the relationship between debt dynamics, and the probabilistic distribution of the primary balance and the effective interest rate. This proposed approach is useful in situations where the lack of relevant data makes it difficult to estimate detailed fiscal reaction functions. Applying this approach to Low-Income Developing Countries (LIDCs) and based on various debt ceiling assumptions, we find that about 60 percent of these countries presently have fiscal policy space to address adverse shocks, subject to the availability of domestic and external financing. Countries with strong institutional capacity tend to have more fiscal space, and countries with weak institutional capacity, mostly countries in conflict and fragile states, tend to lack fiscal space.

Keywords: Fiscal space, Low-income developing countries, Debt ceilings, Public debt, Debt sustainability, Fiscal space, debt dynamics, low-income developing countries

JEL Classification: H62, H63

Suggested Citation

Adedeji, Olumuyiwa and Ahokpossi, Calixte and Battiati, Claudio and Farid, Mai, A Probabilistic Approach to Fiscal Space and Prudent Debt Level: Application to Low-Income Developing Countries (August 2016). IMF Working Paper No. 16/163. Available at SSRN: https://ssrn.com/abstract=2882600

Olumuyiwa Adedeji (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Calixte Ahokpossi

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Claudio Battiati

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Mai Farid

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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