Sovereign Debt Sustainability and Central Bank Credibility

January 28, 2022

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Tim Willems, and Jeromin Zettelmeyer. Sovereign Debt Sustainability and Central Bank Credibility, (USA: International Monetary Fund, 2022) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This article surveys the literature on sovereign debt sustainability from its origins in the mid-1980s to the present, focusing on four debates. First, the shift from an “accounting based” view of debt sustainability, evaluated using government borrowing rates, to a “model based” view which uses stochastic discount rates. Second, empirical tests focusing on the relationship between primary balances to debt. Third, debt sustainability in the presence of rollover risk. And fourth, whether government borrowing costs below rates of growth (“r < g”) generate a “free lunch” in the sense that debt sustainability does not require future primary surpluses. We argue that liquidity services provided by sovereign debt may indeed lead to a “free lunch”, albeit of limited size. The value of such services depends on the credibility of the central bank, which can be accumulated via prudent policies and subsequently drawn on to allow for looser fiscal policy.

Subject: Debt financing, Debt sustainability, Debt sustainability analysis, External debt, Fiscal policy, Fiscal stance, Public debt

Keywords: Central bank credibility, Credibility function, Credibility of the central bank, Debt crises, Debt financing, Debt sustainability, Debt sustainability, Debt sustainability analysis, Fiscal policy, Fiscal stance, Fiscal-monetary interactions, Marginal utility, Market value, Ponzi scheme, Sovereign debt

Publication Details

Pages:

28
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2022/016
Stock No:

WPIEA2022016
ISBN:

9798400201585
ISSN:

1018-5941

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