Fiscal Space

IMF Staff Position Notes, September 1, 2010

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When debt is in a moderate range, its dynamics are sustainable in the sense that increases in debt elicit sufficient increases in primary fiscal balances to stabilize the debt-to-GDP ratio.
At high debt levels, the dynamics may turn unstable, and the debt ratio may not converge to a finite level.
The framework allows estimation of a “debt limit” consistent with a country’s historical track record of adjustment: without an extraordinary fiscal effort, any debt increment beyond this limit would cause debt to increase without bound.

Debt limit: the critical point above which a country’s normal fiscal response to rising debt becomes insufficient to maintain debt sustainability.
Fiscal space: given a country’s normal pattern of adjustment, the difference between its debt limit and its current level of debt.
The debt limit is not an absolute or immutable barrier and is distinct from any notion of the optimal level of public debt.

The debt limit delineates the point at which fiscal solvency is called into question.
The analysis abstracts entirely from liquidity/rollover risk; therefore, prudence dictates that countries will typically want to be well below their debt limit.
Interpretation: being below the debt limit does not imply absence of risk—countries should consider additional factors beyond the historical adjustment pattern.

Source: Fiscal Space, IMF Staff Position Notes.

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