Interest-Growth Differentials and Debt Limits in Advanced Economies

IMF Working Papers, April 6, 2018

Source details

Canonical URL

Interest-Growth Differentials and Debt Limits in Advanced Economies

Other formats

• Markdown version
• Structured JSON version
• Bundle manifest

Bibliographic details

• Authors: Philip Barrett
• Published: April 6, 2018
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781484350980.001

Overview

• Research question: Do persistently low nominal interest rates mean that governments can safely borrow more?
• Approach: Extension of the model of Ghosh et al. [2013] to allow for persistent stochastic changes in nominal interest and growth rates.
• Key model parameter: the long-run difference between nominal interest and growth rates; if negative, maximum sustainable debts (debt limits) are unbounded.

Methodology

• Empirical methods used:
  • VAR-based methods
  • Spectral-based methods
• Outcome of estimation methods:
  • Both VAR- and spectral-based methods produce negative point estimates of the long-run interest-growth differential, but cannot reject positive values at standard significance levels.

Key Findings

• The long-run difference between nominal interest and growth rates is the critical determinant of whether debt limits are bounded or unbounded.
• Empirical estimates:
  • Negative point estimates for the long-run differential from both VAR- and spectral-based methods.
  • Statistical uncertainty remains: positive values cannot be rejected at standard significance levels.
• Calibration to the UK:
  • Using positive but statistically plausible average interest-growth differentials produces debt limits which increase by only around 5% GDP as interest rates fall after 2008.
  • A tiny change in the long-run average interest-growth differential — from the 95th to the 97.5th percentile of the distribution — is sufficient to move average debt limits by the same amount.

Calibration and Quantitative Results

• Country calibrated: United Kingdom (UK)
• Quantitative illustrations:
  • Debt limits increase by only around 5% GDP as interest rates fall after 2008 under the chosen calibration.
  • Sensitivity: movement from the 95th to the 97.5th percentile of the long-run differential distribution produces an equivalent change in average debt limits.

Policy-Relevant Implications

• Persistence and uncertainty in nominal interest and growth rates matter critically for sustainable public debt assessments.
• Point estimates suggesting negative long-run interest-growth differentials do not, by themselves, imply that higher borrowing is safe because positive values remain statistically plausible.
• Small changes in the assumed long-run average interest-growth differential can imply large changes in estimated debt limits, highlighting high sensitivity and model uncertainty for fiscal space assessments.

Content in this bundle

• Interest-Growth Differentials and Debt Limits in Advanced Economies, WP/18/82, April 2018
  • Interest-Growth Differentials and Debt Limits in Advanced Economies, WP/18/82, April 2018 (Markdown version)
  • Interest-Growth Differentials and Debt Limits in Advanced Economies, WP/18/82, April 2018 (PDF)