Abstract
This study proposes a synthetic visual indicator with which to perform debt sustainability analysis using dynamic general equilibrium models. In a single diagram, we summarized the general equilibrium relationships among economic activity, government budget, and the maximum amount of sustainable public debt. Then, we measured sustainability using the distance of actual debt from the model-consistent maximum debt. This indicator can be implemented with any DSGE model; as a backing theory, we used a neoclassical model augmented with endogenous tax revenues, disaggregated public spending, different production technologies for public and private goods, non-atomistic wage setters in public labor (unions), and a fully specified maturity curve for public bonds. We provided an example of its usage using the case of Greece during the last public debt crisis. To perform the numerical analysis, we developed original software, whose advantage is allowing an audience without expertise in DSGE models to perform general equilibrium debt sustainability analyses without requiring an understanding of the technicalities of DSGE models.
Highlights
The last financial and credit crises again highlighted the issue of excessive public debt and its sustainability
To perform the numerical analysis, we developed original software, whose advantage is allowing an audience without expertise in DSGE models to perform general equilibrium debt sustainability analyses without requiring an understanding of the technicalities of DSGE models
We show that the salient information contained in DSGE models in the intercourse amongst gross domestic product (GDP), fiscal policy, and debt sustainability can be represented in a single diagram in which two steadystate ratios from the model solution are depicted: (i) the primary government spending as percentages of GDP, and (ii) the model-consistent corresponding maximum amount of sustainable debt, which is described by the level of the economic activity
Summary
The last financial and credit crises again highlighted the issue of excessive public debt and its sustainability. The sustainability of public debt is analyzed using empirical (reduced-form) equations in which a set of parameters is taken as given (typically the interest rate, inflation, and the growth rate of real GDP), and sustainability is defined as a condition relating the level of debt with public accounts [1]. Treaty conditions, have two main drawbacks: First, they provide policy prescriptions as if the only objective of fiscal policy is fiscal consolidation This may have been reasonable in periods such as the Great Moderation, when developed economies were characterized by moderate cyclical fluctuations and monetary policy was able to stabilize the economic cycle alone. Fiscal policy is used as a countercyclical tool to stabilize the economy, and this often conflicts with fiscal consolidation, as noted by [3,4]
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