The speaker will describe a simple measure of maximum sustainable government debt for advanced economies, based on the country’s expected primary surplus, the level and volatility of its rate of growth and, most importantly, how much debt the government can raise in the future. This last factor points to the existence of a borrowing multiplier that lifts a country’s debt level way beyond what would initially be viable, were it not for the possibility to service maturing debt out of new debt’s proceeds. Current debt is sustainable when the implied future debt is suitably contained. A country’s probability of default exhibits marked asymmetry around its maximum sustainable debt (MSD), increasing slowly below it but very rapidly at higher levels. The measure is calibrated for 23 OECD countries: Korea has the highest MSD at 281% of its GDP, while Greece has the lowest at 89%. Probabilities of default at MSD are extremely low, ranging from Norway’s 0.27% to Korea’s 0.81%. In 2010 most countries’ debt-to-GDP ratio was below their MSD, albeit with some countries’ above, generally those that received some kind of support in the wake of the financial crisis.
Professor of Economics, Center for Monetary and Financial Studies (CEMFI)
Co-editor, Journal of the European Economic Association (JEEA)