Public Debt Sustainability Criteria: A Reappraisal – SustainDebt

Whether public debt can be sustained is a crucial consideration in any macroeconomic analysis of fiscal policy. However, currently, there is no satisfactory criterion for assessing the sustainability of public debt. Existing macroeconomic models on debt sustainability suffer from (a) internal inconsistency because they require nonmodeled social factors to account for the government’s ability to generate a primary fiscal surplus and (b) external inconsistency because they overlook the effects of debt-servicing costs and low-interest rate environments. The SustainDebt project addresses these two inconsistencies in the design of debt sustainability criteria. The first line of research aims to propose more realistic criteria through theoretical modeling based on endogenous growth models. I aim to challenge the prevailing paradigm suggesting that a positive response of the primary fiscal surplus to debt/GDP ratios is sufficient to ensure sustainability. I will explore how governments can secure sustainability when the adjustment of the primary surplus hinges on debt-servicing costs and default risk. I will also develop a micro-foundation that accounts for societal resistance to tax hikes and spending cuts by relying on rent-seeking mechanisms. This model will suggest innovative variables for evaluating debt sustainability, including securing property rights. The second line of research focuses on empirical analyses to reassess knowledge regarding the long-term fiscal policy behavior in Western countries and test theoretical predictions. I will investigate the dynamics of the primary fiscal surplus, considering debt-servicing costs and social/political variables, including political polarization. With insight gained from the designed debt sustainability criteria, I will propose new fiscal rules that can be implemented in the European Union.