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Public Debt Sustainability Under Uncertainty : An Invariant Set Approach

Rozenov, Rossen, (2017), «Public Debt Sustainability Under Uncertainty : An Invariant Set Approach», IMF Working Paper, 13 Μαρτίου

The question of what level of public debt a country can afford is central to fiscal policy. Vast literature is devoted to debt sustainability and an array of tools has been developed to guide assessment. A comprehensive review of previous work on the subject is beyond the scope of this paper and is not attempted here. We only mention a few studies to provide a context for the subsequent discussion and illustrate some of the difficulties that arise in the analysis.

Most of the earlier contributions have focused on ensuring solvency, interpreted as compliance with the government’s intertemporal budget constraint. For example, Blanchard et al. (1990) derived a simple sustainability criterion according to which the current level of debt should not exceed the present value of all future primary surpluses. This condition follows directly from the dynamic equation describing the evolution of debt and is relatively mild in the sense that it only requires the discounted value of future debt to tend to zero. Thus, debt trajectories that increase indefinitely as time goes to infinity are not ruled out as long as the rate of increase is lower than the interest-growth differential. Variants of this solvency condition have been widely used in the literature, e.g., EU Commission (2006) and Escolano (2010), among others.

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