Public debt sustainability

Abstract

Public debt is a basic instrument for optimally distributing public policies over time. Through public indebtedness, the provision of public goods can be temporally disassociated from the taxation process required to fund it. For the debt instrument to fulfill its role, debt holders must believe that policies are such that contracts will be fulfilled. This requires fiscal policy to be sustainable. This chapter focuses on three areas. First, it formalizes the idea of a sustainable fiscal policy. Second, it presents different evaluation measures that offer disciplined ways to assess whether a policy is sustainable. Last, it shows how the management of public debt plays a critical role in determining its sustainability. A country's public debt is considered sustainable when government budget constraints can be met without disrupting its monetary and fiscal policies. As the chapter will clarify, this implies that the amount of the public debt should not exceed the present value of all future primary surpluses. The concept of maintaining stable monetary and fiscal policy is crucial. Ultimately, government budget constraints can be met by acknowledging circumstances in which default on the debt (non-payment) or monetization will occur in ways that are consistent with mathematical expressions. In this case, the equations no longer represent true budget constraints but are rather pricing equations that answer the question about what is the current value of this debt which may not be payed. Pricing equations allow two assets with identical contractual payment promises to have different market prices. Underlying the price difference is the perception that some contractual promises will not be kept. In contrast, an equation that represents a budget constraint must anticipate full payment in all periods and under all circumstances. Thus, the latter is the relevant concept for defining sustainability.