Interest-Growth Differentials and Debt Limits in Advanced Economies

No 2018/082, IMF Working Papers from International Monetary Fund

Abstract: Do persistently low nominal interest rates mean that governments can safely borrow more? To addresses this question, I extend the model of Ghosh et al. [2013] to allow for persistent stochastic changes in nominal interest and growth rates. The key model parameter is the long-run difference between nominal interest and growth rates; if negative, maximum sustainable debts (debt limits) are unbounded. I show how both VAR- and spectral-based methods produce negative point estimates of this long-run differential, but cannot reject positive values at standard significance levels. I calibrate the model to the UK using positive but statistically plausible average interest-growth differentials. This produces debt limits which increase by only around 5% GDP as interest rates fall after 2008. In contrast, only a tiny change in the long-run average interest-growth differential – from the 95th to the 97.5th percentile of the distribution – is required to move average debt limits by the same amount.

Keywords: WP; interest-growth differential; critical value; nominal interest rate; Fiscal policy; Government Debt; Uncertainty; debt level; debt maturity; point estimate; debt price; default premium; time series; upper bound; Debt limits; Debt sustainability; Vector autoregression; Debt default; Global (search for similar items in EconPapers)
Pages: 55
Date: 2018-04-06
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Citations: View citations in EconPapers (12)

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