Fiscal Space, Prepared by Jonathan D. Ostry, Atish R. Ghosh, Jun I. Kim, and Mahvash S. Qureshi, September 1, 2010, IMF Staff Position Note
“The fiscal challenges facing advanced economies are unprecedented, and bring to the fore questions about how to assess fiscal sustainability. Intertemporal solvencythe notion that governments eventually repay their debtsrequires only that adjustments to bring debt dynamics back on track occur at some point in the future. Given the sovereigns right to tax and (not) spend, changes in these variables can always make the problem of insolvency disappear. But markets are not impressed by promises that are unsupported by countries track record of adjustment (words unsupported by deeds), and so it is critical to examine this track record to see whether it is indeed consistent with satisfying the intertemporal constraint. In this note, we reexamine the issue of debt sustainability in a large group of advanced economies. Our hypothesis is that, when debt is in a moderate range, its dynamics are sustainable in the sense that increases in debt elicit sufficient increases in primary fiscal balances to stabilize the debt-to-GDP ratio. At high debt levels, however, the dynamics may turn unstable, and the debt ratio may not converge to a finite level. Such a framework allows us to define a debt limit that is consistent with the countrys historical track record of adjustment in the sense that, without an extraordinary fiscal effort, any debt increment beyond this limit would cause debt to increase without bound.”
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