A stochastic indicator for sovereign debt sustainability

Abstract

We propose a stochastic indicator to assess government debt sustainability. This indicator combines the effect of economic uncertainty –represented by stochastic simulations of interest and growth rates– with the expected fiscal response that provides information on the long-term country specific attitude towards fiscal sustainability. We apply our framework on post-war data for nine OECD countries and find that our indicator –the potential increase in debt in bad states of the world– distinguishes countries that have sustainability concerns: Italy, Spain, Portugal and Iceland, from those that do not: United States, United Kingdom, Netherlands, Belgium and Germany.