When is debt a menace? The economic and political aspects of debt sustainability

Barta, Zsófia (2011) When is debt a menace? The economic and political aspects of debt sustainability. [Conference Proceedings]

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Abstract

Just when it seemed like sovereign default was a virtual impossibility in the developed world, the turmoil in sovereign debt markets triggered by explosive debt growth in the wake of the financial crisis raised new fears about fiscal prospects in many advanced economies. However, assessing the severity of the situation is complicated by the fact that no definitive empirical or theoretical benchmark exists for sovereign solvency. This paper reviews the literature on solvency, sustainability and default as well as recent expert contributions about the severity of the present fiscal situation in the developed world and finds that the difficulties involved in determining the dangers entailed in outstanding debt include not only the need to deal with economic uncertainty surrounding the ability of the given sovereign to pay, but also-and the paper argues in the case of developed countries more importantly-gauging the political context determining the willingness of the sovereign to service debt. It then goes on to explore the ways in which markets gauge this degree of willingness, using rating agencies' sovereign rating methodologies as a proxy for markets' approach to creditworthiness and quoting examples of ratings changes in the recent past to see what degree the considerations listed in the rating methodologies are applied in practice. It concludes that increased nervousness about sovereign default might lead to a more intrusive influence by market actors on a broader range of policy and institutional issues in developed countries than before.

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