## Watch This (Fiscal) Space: Assessing Room for Fiscal Maneuver in Advanced Countries

_IMF Blog, September 1, 2010_

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## Bibliographic details
- Authors: Jonathan D Ostry
- Published: September 1, 2010

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### Problem statement: rising fiscal concerns in advanced economies
- Public debt sustainability in most advanced economies moved from a non-issue to a key policy concern.
- The reassessment of sovereign risk is a palpable threat to global recovery.
- The debt blowout in advanced countries reflects pre-crisis fiscal management as well as the financial crisis.
- Taming public debt will require steadfast policy efforts over the medium term; quick fixes will not do the trick.

### Operational approach and methodology
- The note provides an operational definition of “fiscal space” and empirical estimates of available fiscal space for 23 advanced economies.
- Fiscal space is assessed by focusing on fiscal solvency in terms of the actual track record of countries—how policy responded in the past to changes in public debt.
- Key empirical premise: if governments historically raised the primary budget balance (net of interest payments) when public debt rose, they exhibited an implicit rule of making sure debt would be repaid.
- The analysis recognizes that the positive response of the primary balance to rising debt holds only up to a point; beyond a threshold a debt limit is reached when adjustment fatigue sets in.
- The framework incorporates the role of market-imposed risk premia: as debt approaches its limit, markets add a risk premium to sovereign interest rates, making hitting the debt limit more likely.

### Main findings
- Advanced countries differ substantially in available fiscal space: some have a lot, others have none, and some are in the middle.
- Fiscal space varies across countries for two reasons: differing indebtedness, and different debt limits determined by each country’s track record of adjustment.
- Markets require credible historical evidence of adjustment; promises unsupported by past deeds are unlikely to reassure markets.
- When debt nears its limit, markets typically add a risk premium that increases borrowing costs and accelerates the path to the debt limit.
- A finding of little or no fiscal space does not imply inevitable default—debt limits are not etched in stone because behavior and policy can change.

### Policy implications and recommendations
- Where a country has little or no fiscal space, fiscal policy needs to break fundamentally from the past to credibly signal to markets that debt limits will not be reached: business as usual simply won’t cut it.
- Because estimates assume future policy reactions will mirror past behavior, credible policy change can expand fiscal space—“history is not destiny.”
- Countries should generally target debt levels well below estimated limits because:
  - Markets may give little or no warning about imminent spikes in borrowing costs or curtailed access to debt markets.
  - There is inevitable uncertainty about where precisely debt limits lie and potential for rapid changes in market perceptions.
- If fiscal risks rise, political willingness is required to undertake adjustment efforts that are extraordinary by historical standards, and to do so in a timely fashion, to preserve or restore sustainability.
- Maintaining a comfortable degree of fiscal space at all times is prudent policy given the potential suddenness of market reassessments.

### Intended contribution of the framework
- The framework aims to clarify a fuzzy concept—fiscal space—and provide practical guidance on where a change of course is called for, as well as the size and nature of adjustments needed to manage fiscal risks.
- The framework underscores that there is no “one size fits all”: debt limits and fiscal space are country-specific and depend on each country’s track record of adjustment.

*Source: Jonathan D. Ostry, September 1, 2010. The IMF is an organization of 191 countries, based in Washington D.C.*

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- **Staff Paper**
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_Source: https://www.imf.org/en/blogs/articles/2010/09/01/watch-this-fiscal-space-assessing-room-for-fiscal-maneuver-in-advanced-countries_