US Government Debt Different - Finance Department - University of ...

James Kwakkeep the national debt at a sustainable level? This is a difficult questionto answer, in part because it is not enough for individual politiciansto be willing to reduce deficits on their terms; what matters iswhether the political system as whole can generate a set of policiesthat will achieve fiscal sustainability.139One possible approach is to use historical data to assess whether acountry is likely to make the fiscal adjustments necessary to manageits debt successfully. In a recent paper, Jonathan D. Ostry, Atish R.Ghosh, Jun I. Kim, and Mahvash S. Qureshi of the IMF used differentcountries’ past willingness to pay—that is, to improve primarybudget balances in the face of rising debts—in estimating the “fiscalspace” available to them today. 35 The core of their analysis is a “fiscalreaction function” that shows how the primary balance responds tochanges in debt levels: over some range of debt levels, as debt increases,countries tend to increase their primary balances in response,which has the effect of lowering the debt. Beyond some point, however,it gets harder and harder to raise taxes or to cut spending further;as a result, improvements in the primary balance will not belarge enough to compensate for rising interest payments, and thedebt will therefore continue to increase indefinitely. Because creditorsare aware of this possibility, they will demand higher interestrates as the debt approaches this point, compounding the problem.Ostry et al. define a country’s debt limit as the level of debt (as a percentageof GDP) beyond which debt becomes unsustainable. Fiscalspace is the difference between this debt limit and the current levelof debt.Ostry et al. use the fiscal reaction function to estimate the debt limitfor twenty-three different countries. For the United States, they estimatethe debt limit to be between 160 and 183 percent of GDP. 36These figures are based on general government debt, including obligationsof state and local governments (but not intra-governmental35 Jonathan D. Ostry, Atish R. Ghosh, Jun I. Kim, and Mahvash S. Qureshi, “FiscalSpace,” IMF Staff Position Note SPN/10/11, September 1, 2010.36 The estimates differ depending on whether they use market interest rates forgovernment debt or a model that estimates how the interest rates will rise as debtapproaches the debt limit. In the former case, they calculate the debt limit usingboth historical and projected interest rates. Ibid., pp. 11–12.