Debt Sustainability in a Low Interest Rate World

69 Pages Posted: 22 Sep 2020

See all articles by Neil Mehrotra

Neil Mehrotra

affiliation not provided to SSRN

Dmitriy Sergeyev

Bocconi University

Date Written: September 1, 2020

Abstract

Conditions of secular stagnation—low output growth g and low interest rates r—have counteracting effects on the cost of servicing public debt, r − g. Using data for ad- vanced economies, we document that r is often less than g, but r − g exhibits substan- tial variability over the medium-term. We build a continuous-time model in which the debt-to-GDP ratio is stochastic and r < g on average. We analytically characterize the distribution of the debt-to-GDP ratio, showing how two candidate explanations for low interest rates, slower trend growth and higher output risk, can lower the debt- to-GDP ratio. When the primary surplus is bounded above, we characterize a fiscal limit, above which default occurs, and a debt tipping point, above which the pub- lic debt is on an unsustainable path, but default does not occur immediately. Slower trend growth and higher output risk can paradoxically improve debt sustainability. A conservative calibration suggests a fiscal limit for the US of 184 percent of GDP and a tipping point of 115 percent of GDP.

Suggested Citation

Mehrotra, Neil and Sergeyev, Dmitriy, Debt Sustainability in a Low Interest Rate World (September 1, 2020). CEPR Discussion Paper No. DP15282, Available at SSRN: https://ssrn.com/abstract=3696363

Neil Mehrotra (Contact Author)

affiliation not provided to SSRN

No Address Available

Dmitriy Sergeyev

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

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