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Estimated Fiscal Reaction Functions and the Calculation of Sustainable Government Net Debt Limits for the US and 24 Other OECD Countries
This paper calculates sustainable sovereign net debt limits for 25 OECD countries, updating and enhancing the model in Ghosh et al. (2013). Fiscal reaction functions are estimated over a recent time period, confirming the fiscal fatigue hypothesis, where net debt levels exceeding 150% of GDP begin to impair a country’s ability and desire to manage public spending and deficits. Using historical, current, and dynamic interest rate-to-economic growth differentials, countries’ sustainable debt limits are calculated on a net of central bank holdings of government debt basis. Sustainable net debt limits average 234 percent of GDP for these countries assuming historical rates and economic growth (221 percent for the US), 214 percent assuming (higher) current interest rates and economic growth (186 percent for the US. If, however, interest rates were to rise systematically with debt according to conservative assumptions, there is no model solution for France, Greece, Japan, Italy, the UK, and the US, given their current high debt levels; the average sustainable limit is 178 percent for the other countries. A reasonable conclusion to draw for the US is that the fiscal path under current policy and trends with rising interest rates is not sustainable in the short to intermediate term.
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