Fiscal Rules for Debt Sustainability in Emerging Markets: The Impact of Volatility and Default Risk

26 Pages Posted: 28 Sep 2006

See all articles by Adrian Penalver

Adrian Penalver

Bank of England

Gregory Thwaites

Bank of England - Monetary Analysis

Date Written: September 2006

Abstract

The determinants of public debt dynamics - real interest rates, the real exchange rate, output growth and the primary fiscal balance - are typically more volatile in emerging market economies than in industrialised countries. Capital markets also typically demand higher interest rates from emerging markets when their debt dynamics deteriorate. This paper considers how these characteristics affect the choice of fiscal policy rules in emerging markets. We estimate an econometric model of the determinants of public debt dynamics on Brazilian data and use this model to simulate the effect of different fiscal policy rules for future paths of debt. We then derive the set of fiscal policy rules which stabilise public debt dynamics. We find that macroeconomic forecast uncertainty and feedback among the endogenous variables (principally from the debt-GDP ratio to interest rates) force the policy rule to be significantly more responsive to changes in public debt. Rules that would stabilise debt in a fully known world may not do so when the policymaker is faced with a realistic pattern of shocks. The method we employ may be a useful addition to the toolkit of domestic and international policymakers when assessing fiscal rules and debt sustainability.

Suggested Citation

Penalver, Adrian and Thwaites, Gregory, Fiscal Rules for Debt Sustainability in Emerging Markets: The Impact of Volatility and Default Risk (September 2006). Bank of England Working Paper No. 307, Available at SSRN: https://ssrn.com/abstract=933299 or http://dx.doi.org/10.2139/ssrn.933299

Adrian Penalver (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Gregory Thwaites

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
302
Abstract Views
1,323
rank
128,894
PlumX Metrics