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Sustainability gap of public debt: importance of interest rates and a new decomposition with premia

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  • Elmar Dönnebrink

    (Bundesministerium der Finanzen (BMF))

  • Nils Grevenbrock

    (Bundesministerium der Finanzen (BMF))

Abstract

Sustainability gaps (S2 indicators) are frequently used in national and international reports to assess the sustainability of public finances. For instance, in the European Commission’s Debt Sustainability Monitor (DSM) the indicators are analyzed in comparisons across (policy) scenarios, countries and time. The report’s findings play a crucial role in the context of the Stability and Growth Pact and the European Semester. As a result, sustainability gaps have a significant indirect influence on policy decisions. In this paper, we analyze two non-transparent properties of these indicators. First, the response of these indicators to changes in the interest rate-growth (r-g) differential is not readily predictable in terms of both strength and direction. Second, in our examples for low values of r-g (in a range of 0.5%), highly uncertain projections for distant periods after 2070 explain about 80% of the indicators’ values. To address these problems, we develop a new decomposition that takes into account the notion of premia (Reis 2021) and hence allows for a more transparent discussion of the sustainability of public debt.

Suggested Citation

  • Elmar Dönnebrink & Nils Grevenbrock, 2022. "Sustainability gap of public debt: importance of interest rates and a new decomposition with premia," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 49(4), pages 1009-1030, November.
    • Handle: RePEc:kap:empiri:v:49:y:2022:i:4:d:10.1007_s10663-022-09552-x
    DOI: 10.1007/s10663-022-09552-x
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    References listed on IDEAS

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    1. Ostry, Jonathan D. & Debrun, Xavier & Willems, Tim & Wyplosz, Charles, 2019. "Public Debt Sustainability," CEPR Discussion Papers 14010, C.E.P.R. Discussion Papers.
    2. Bayer, Christian & Born, Benjamin & Luetticke, Ralph, 2023. "The liquidity channel of fiscal policy," Journal of Monetary Economics, Elsevier, vol. 134(C), pages 86-117.
    3. Ricardo Reis, 2021. "The constraint on public dept when r," BIS Working Papers 939, Bank for International Settlements.
    4. Laurence Ball & N Gregory Mankiw, 2023. "Market Power in Neoclassical Growth Models," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 90(2), pages 572-596.
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    6. Mr. Julio Escolano, 2010. "A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates," IMF Technical Notes and Manuals 2010/002, International Monetary Fund.
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    1. Werding, Martin & Läpple, Benjamin & Schirner, Sebastian, 2024. "Modellrechnungen für den Sechsten Tragfähigkeitsbericht des BMF," FiFo Reports - FiFo-Berichte 33, University of Cologne, FiFo Institute for Public Economics.

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    More about this item

    Keywords

    Public debt; Interest rates; Fiscal sustainability; Public budget;
    All these keywords.

    JEL classification:

    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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