Political economy of government solvency: the institutional framework for stability and sustainability

Unhealthy and potentially unsustainable debt dynamics have been affecting advanced as well as developing economies. In this chapter we take stock of government obligations and private debt that could migrate to public balance sheets. We analyse different approaches to dealing with debt overhangs which have been pursued at various times. Building on past experiences, we discuss institutional mechanisms to achieve and preserve debt sustainability. Strong rules and institutions, clear accountability and credible enforcement procedures are essential to regain fiscal discipline and avert a potential future systemic fiscal crisis. We reject implicit or outright default as an acceptable way out of debt. Instead, we advocate strengthening national and international institutional underpinnings in order to ensure that contracting parties are able and willing to serve the commitments they have made.