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Is the Maastricht debt limit safe enough for Slovakia?

Author

Listed:
  • Zuzana Mucka

    (Council for Budget Responsibility)

Abstract
We study the interactions among fiscal policy, fiscal limits and sovereign risk premia. The fiscal limit, which measures the government’s ability to service its debt, arises endogenously from dynamic Laffer curves and is a random variable. A nonlinear relationship between sovereign risk premia and the level of government debt then emerges in equilibrium. The model is calibrated to Slovak data and we study the impact of various model parameters on the distribution of the fiscal limit. Fiscal limit distributions obtained via Markov–Chain–Monte–Carlo regime switching algorithm depend on the rate of growth of government transfers, the degree of countercyclicality of policy, and the distribution of the underlying economic conditions. We find that it is considerably more heavy–tailed compared with the one usually obtained in the literature for advanced economies, and is very sensitive to the size and rate of growth of transfers. The main policy message is that the Maastricht debt limit is not safe enough for Slovakia: although in the equilibrium the chance of country default is 10 percent when the debt is 60 percent of GDP, it increases dramatically to approximately 40 percent in bad times (when productivity falls by almost 8 percent). A well-designed fiscal policy involving a deceleration in the growth of transfers can reduce the chance of default significantly.

Suggested Citation

  • Zuzana Mucka, 2015. "Is the Maastricht debt limit safe enough for Slovakia?," Working Papers Working Paper No. 2/2015, Council for Budget Responsibility.
    • Handle: RePEc:cbe:wpaper:201502
    as

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    References listed on IDEAS

    as
    1. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
    2. Huixin Bi, 2010. "Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy," CAEPR Working Papers 2010-007, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    3. Ludovit Odor & Judita Jurasekova Kucserova, 2014. "Finding Yeti: More robust estimates of output gap in Slovakia," Working Papers Working Paper No. 2/2014, Council for Budget Responsibility.
    4. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
    5. Huixin Bi & Nora Traum, 2012. "Estimating Sovereign Default Risk," American Economic Review, American Economic Association, vol. 102(3), pages 161-166, May.
    6. Ludovit Odor, 2014. "Fiscal Risk Assessment at the CBR: A Conceptual Framework," Discussion Papers Discussion Paper No. 1/20, Council for Budget Responsibility.
    7. Coleman, Wilbur John, II, 1991. "Equilibrium in a Production Economy with an Income Tax," Econometrica, Econometric Society, vol. 59(4), pages 1091-1104, July.
    8. Huixin Bi & Eric M. Leeper, 2010. "Sovereign Debt Risk Premia and Fiscal Policy in Sweden," NBER Working Papers 15810, National Bureau of Economic Research, Inc.
    9. Huixin Bi & Eric M. Leeper, 2013. "Analyzing Fiscal Sustainability," Staff Working Papers 13-27, Bank of Canada.
    10. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Simulation Methods and Modelling; Fiscal Policy; Government Expenditures; Debt Management and Sovereign Debt;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H5 - Public Economics - - National Government Expenditures and Related Policies
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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