The governments response to the COVID-19 pandemic left Latin America and the Caribbean economies with increased levels of sovereign debt as a percentage of output, bringing up the question of debt sustainability in the region. The literature has identified two testable conditions on the fiscal reaction function for debt sustainability: i) a positive response of primary balances to debt (Bohn, 1995) and ii) the response of primary balances to debt should be higher than the growth adjusted interest rate (Ghosh et al., 2013). This paper revisits these conditions, both from the theoretical and empirical perspective. It introduces a new “implicit growth” measure which is the relevant one for the debt-to-GDP ratio dynamics. It also tests empirically both conditions for economies in the region. The results suggest that debt is likely sustainable in the region, although it cannot be assured at a 95 percent confidence level. A deep look at the causes of this results pointed towards fiscal fatigue, the fact that primary balances become less responsive to debt levels the higher the latter are. At post-pandemic debt levels sustainability is far from certain. The results here indicate decisive action is required to ensure debt will fall back to prudent levels.

We aim to evaluate the public debt sustainability of Pakistan using the debt sustainability analysis (DSA) framework and fiscal reaction function (FRF). For the empirical analysis, we use relevant important macroeconomic variables, such as public debt, external debt, primary balance, output growth, current account balance, and oil prices, over the period 1976–2021. The results of the DSA suggest that, at the 10% growth rate with a real interest rate lower than 10%, the public debt level can be brought under the 60% standard sustainable limit from the current 80% by the year 2030. Furthermore, the estimates of the FRF reveal no evidence of debt sustainability. Besides this, the COVID-19 pandemic is positively associated with the primary balance mainly due to the decrease in the primary balance from –3.5% in 2019 to –0.9% in 2020. This is expected as a large amount of debt relief was provided to Pakistan during this period. Overall, our findings indicate that, if the rapid debt accumulation trend continues, the country will be unable to bear such a hefty load of ballooning debt. Therefore, a strategy of continuing coordination of fiscal and monetary policy is crucial for robust growth momentum to keep the debt sustainable.

Under the Quantitative and Qualitative Monetary Easing (QQE), the Bank of Japan has purchased long-term Japanese government bonds. To study monetary policy after the Bank of Japan exits from the QQE, we develop a model in which the fiscal authority commits: (ⅰ) not to making fiscal adjustments needed to stabilize public debt, and (ⅱ) not to providing financial supports for the central bank that incurs losses on its balance sheet due to a decline in the price of long-term bonds. Within this framework, this study investigates how the interaction of these commitments reduces the ability of monetary policy to control inflation after liftoff from the zero lower bound. We consider a situation in which the central bank that holds long-term bonds raises the nominal interest rates and show two key results: (ⅰ) when the Taylor principle is not satisfied, under certain conditions, inflation right after liftoff cannot overshoot the central bank’s target; (ⅱ) when the central bank follows the Taylor principle, under certain conditions, it cannot prevent the economy from converging to the deflationary steady state.

We review the state of the sovereign debt literature and point out that the canonical model of sovereign debt cannot be easily reconciled with several facts about sovereign debt pricing and servicing. We identify and classify twenty puzzles. Some are well known and documented, others are less so and are sometimes based on anecdotal evidence. We classify these puzzles into three categories: puzzles about how sovereigns issue debt; puzzles about the pricing of sovereign debt; and puzzles about sovereign default and the working out of defaults. We conclude by suggesting possible avenues for new research aimed at reconciling theory with what we observe in the real world.

For emerging economies, borrowing abroad is a double-edged sword: it can buffer against adverse economic shocks and smooth their domestic consumption; however, it can also amplify volatility in consumption, depending on the currency in which the debt is denominated and cyclicality in the borrower’s exchange rate. We empirically investigate the nexus among external debt portfolios, exchange rate cyclicality, and volatility in consumption of low- and middle-income countries. Since 1980, many countries have concentrated their external debt portfolios’ currency composition. By constructing debt-weighted effective exchange rates, we find that currency concentration magnifies exchange rate pro-cyclicality, making domestic consumption more volatile when national income fluctuates. Our results endorse diversifying the currency composition of external debt to mitigate the negative consequences of “original sin.”

This paper assesses the impact of the two main direct channels through which tensions in sovereign bond markets are transmitted to banks’ balance-sheets and to their ability to provide credit. In particular, it disentangles the effect stemming from the worsening in banks’ capitalization (balance sheet channel) from that associated with a reduced ability to raise funds using government bond holdings as collateral (liquidity channel). The results indicate that, after the sudden rise in yields on Italian government bonds observed in May 2018, the banks with a higher ratio of those bonds to total assets reduced credit supply to firms more, in line with the literature. The work also shows that the more marked credit contraction mainly reflected the negative shock on bank capitalization, while the liquidity channel would not be activated.

In the current situation, Pakistan is not only suffering from a political crisis but also from a severe economic crisis. At present, Pakistan cannot bear the burden of any kind of minor crisis, whether it is social, political, economic any other type of crisis. At present, the external debt of Pakistan is $110b Billion & internal debt in Pakistan also touching the sky The public debt of Pakistan is around 54 Trillion PKR ($248.7Billion) which is 80.2 percent of the Gross Domestic Product. At present Pakistan is taking a package of $1 Billion from the IMF (International Monetary Fund), At the same time, floods start in the northern province of Pakistan KPK (Khyber Pakhtunkhwa) area in Pakistan & causing irreparable damage to this province as well also spreading destruction through south Punjab Province & its adjacent area & also spread destruction in Provinces Sindh & Balochistan. According to a conservative estimate, the flood caused an economic loss of $30 billion in Pakistan's quarter of the country's external debt.

We incorporate monetary policy into a model of stochastic debt sustainability analysis and evaluate the impact of unconventional policies on sovereign debt dynamics. The model optimizes debt financing to trade off financing cost with refinancing risk. We show that the ECB pandemic emergency-purchase programme (PEPP) substantially improves debt sustainability for euro area sovereigns with a high debt stock. Without PEPP, debt would be on an increasing (unsustainable) trajectory with high probability, while, with asset purchases, it is sustainable and the debt ratio is expected to return to pre-pandemic levels by about 2030. The improvement in debt dynamics extends beyond the PEPP and is larger for more gradual unwinding of the Central Bank balance sheet. Optimal financing under PEPP induces an extension of maturities reducing the risk without increasing costs. The analysis also shows that inflation surprises have relatively little impact on debt dynamics, with the direction and magnitude of the effect depending on the monetary policy response.

This paper employs a two-country New Keynesian DSGE model to assess the macroeconomic impact of the changes in monetary policy frameworks and the fiscal support in the U.S. and euro area during the pandemic. Moving from a previous target of “below, but close to 2 percent” to a formal symmetric inflation targeting regime in the euro area or from flexible to average inflation targeting in the U.S. is shown to boost output and inflation in both regions. Meanwhile, the fiscal packages approved in the U.S. and the euro area, and a slower withdrawal of fiscal support in the euro area, have a similar impact on output and inflation as changing the monetary policy frameworks. Simultaneously implementing these policies is mutually reinforcing, but insufficient to fully explain the unexpected increase in core inflation during 2021.

The growing asymmetry in the size of fiscal imbalances poses a serious challenge to the macroeconomic stability of the Euro Area (EA). We show that following a contractionary shock, the current monetary and fiscal framework weakens economic growth even in low-debt countries because of the zero lower bound (ZLB) constraint. At the same time, the current framework also exposes the EA to the risk of fiscal stagflation if one country were to refuse to implement the necessary fiscal consolidations. We study a new framework that allows EA policymakers to separate the need for short-run macroeconomic stabilization from the issue of long-run fiscal sustainability. Following a contractionary shock, the central bank tolerates the increase in inflation needed to stabilize the amount of Eurobonds issued in response to a large EA recession. National governments remain responsible to back their country-level debt by fiscal adjustments. The policy acts as an automatic stabilizer that benefits both high-debt and low-debt countries, generating a moderate increase in inflation that mitigates the recession and allows the central bank to move away from the ZLB. At the same time, the proposed policy lowers the risk of fiscal stagflation because it endows EA countries with effective stabilization policies.

Does it payoff to be transparent and, if so, can the benefits of transparency be measured? This paper provides an affirmative answer to both questions, supported by novel evidence on the link between transparency through dissemination of economic data and sovereign bond spreads. It explores changes in sovereign financing conditions when countries join the IMF Data Standards Initiatives—a multilateral framework that promotes data transparency as a global public good. The results from event studies and local projection models show a significant decrease in spreads following the adoption of the standards. In addition, countries with relatively weaker governance benefit the most from signaling their effort toward strengthening transparency.

The paper evaluates the key drivers of fiscal crises in a sample of countries from all three income groups—advanced, emerging, and low-income countries, using fiscal crisis data recently developed by the IMF’s Fiscal Affairs Department. The empirical study focuses on three questions: (1) How does the composition of debtholders (domestic vs. foreign, resident vs. non-resident, or official vs. non-official) affect the probability of a fiscal crisis, after controlling for the level of public debt and other relevant variables?; (2) How does the development and size of the domestic financial sector affect the probability of a fiscal crisis?; and (3) How do changes in the debt level affect the probability of a fiscal crisis, for given compositions of the sovereign debt investor base and different levels of development and size of domestic financial markets? Our findings confirm the benefits of financial development, the danger of heavy reliance on a non-resident investor base, and also that emerging market economies have a lower debt carrying capacity compared to the full sample.

We construct a high-frequency dataset that combines information on all IMF lending and proxies of monthly economic activity during the first two years of the COVID-19 pandemic (2020–21). Using this novel dataset and standard econometric techniques we find a positive and significant marginal effect of IMF financing on economic activity in low-income countries (LICs) and emerging market economies. We also present tentative evidence that IMF financing may have helped economic outcomes by easing fiscal budget constraints, allowing for larger government spending in response to the pandemic. Overall, this evidence suggests that IMF financing helped lessen the negative impacts of the pandemic on economic activity, especially in LICs.

This paper explores the empirical determinants of external crises on a world panel dataset of 62 countries over the fifty-year period 1970-2019 and estimates their risk trade-offs with the aim of informing macrofinancial prudential policies. The determinants include countries external balance sheets, macroeconomic imbalances, and structural and global factors. It finds that information on the composition of gross positions in countries external financial portfolios is required to gauge the risk of external crisis: debt liabilities are the riskiest component, FDI liabilities are half as risky, and FDI assets are the most protective. Macroeconomic imbalances increase risk but are usually not the key drivers of crises. Adverse global shocks significantly leverage domestic risks. International reserves are powerful risk mitigants that provide high insurance value. The evidence shows that advanced economies are structurally more resilient to withstand exposure to weak external portfolios, macroeconomic imbalances, and global shocks. For the average country the risk of external crisis is on a declining trend mainly driven by improvements in the composition of external portfolio assets magnified by increasing financial integration as well as rising international reserves.

A textbook argument in favor of adopting another country’s legal tender is that it imposes strong constraints on money creation and therefore fiscal dominance. In Ecuador, an officially dollarized economy since January 2000, a series of accounting practices and subsequent changes in legislations approved over the period 2009-2014 allowed an expansion of the Central Bank of Ecuador’s (CBE) balance sheet to finance the central government. At its peak, central bank financing of the government represented 10 percent of GDP. This resulted in large liabilities to the CBE that translated into low reserve coverage, putting the public and private financial systems and ultimately the dollarization regime at risk. In this paper, we first present the legal and accounting processes behind the expansion of the CBE's balance sheet and some stylized facts. In the second section, we establish a stress test-like methodology to show how the expansion of the CBE’s balance sheet induced strong pressures on CBE’s liquidity. Ultimately, such liquidity stress at the CBE translated into high cash inflows needs, i.e. external debt, for the central government.

Evidence suggests that sovereign defaults disrupt international trade. As a consequence, countries that are more open have more to lose from a sovereign default and are less inclined to renege on their debt. In turn, lenders should trust more open countries and charge them with lower interest rate. In most cases, the country should also borrow more debt as it gets more open. This paper formalizes this idea in a sovereign debt model à la Eaton and Gersovitz (1981), proves these theoretical relations, and quantifies them in a calibrating model. We also provide evidence suggesting a causal relationship between trade and debt or CDS spreads, using gravitational instrumental variables from Frankel and Romer (1999) and Feyrer (2019) as a source for exogenous variation in trade openness.

This paper examines the implications of different types of interest rate shocks in the United States for emerging market and developing economies (EMDEs). It first classifies changes in U.S. interest rates into those caused by changes in inflation expectations (“inflation” shocks), changes in perceptions of the Federal Reserve’s reaction function (“reaction” shocks), and changes in real activity (“real” shocks). The analysis attributes this year’s sharp increases in U.S. interest rates almost exclusively to inflation and reaction shocks. These types of shocks are found to be associated with especially adverse effects: EMDE financial conditions tighten, consumption and investment fall, and governments cut spending to improve budget balances. By comparison, rising U.S. interest rates stemming from real shocks are not only associated with benign outcomes for EMDE financial conditions but also improvements in budget balances that reflect higher revenues as well as lower expenditures. Finally, this paper documents that rising U.S. interest rates driven by reaction shocks are especially likely to push EMDEs into financial crisis.

I estimate the present value of local GDP increases by about 11.4 RMB for 1 RMB increase of government spending during 2001-2019 at the prefecture city level in China, where the local governments play an active role in increasing economic growth. To achieve identification, I construct a novel instrument for local government spending: the fraction of unoccupied raw land in the downtown area in 2000. After 2000, as the local governments increasingly rely on land sales to finance expenditures, a higher fraction of unoccupied raw land is associated with less compensation expense to occupants removed from the land and hence higher net profits from land sales for local governments. Moreover, the fraction of raw land is orthogonal to a rich set of city fundamentals in 2000 and major confounding shocks after 2000. The high multiplier can be explained by the local government financial constraint because it is found to be significantly lower if the local governments have better access to debt financing or face less investment opportunities. The mechanism is consistent with models where government spending is investment. Higher government spending is found to increase employment and private investment, and the total output effect of the increased inputs can explain almost all the increase of local output. The paper highlights the macroeconomic importance of the financial constraint of governments that actively invest to promote economic growth.

We study the debt-stabilizing properties of indexing debt to GDP using a consumption based macro-finance model. To this end, we derive quasi-analytical pricing formulas for any type of bond/equity by exploiting the discretization of the state-space, making large-scale simulations tractable. We find that GDP-linked security prices would embed time-varying risk premiums of about 40 basis points. For a fixed budget surplus, issuing GDP-linked securities does not imply more beneficial debt-to-GDP ratios in the long-run, while the debt-stabilizing budget surplus is more predictable at the expense of being higher. Our findings call into question the view that such securities tame debt.

This study applies quantile regression to a sample of 160 countries over the period 1990-2020 to explore the relationship between fiscal space and different conditional quantiles of government-spending cyclicality.  Moreover, as fiscal space is a multidimensional concept, unlike the literature, which focuses on government debt sustainability, we consider additional dimensions of fiscal space that have received less attention – sovereign balance sheet vulnerability, contingent liabilities arising from the risks of external and private sector debt, and market perception of sovereign risk.  Our analysis suggests that fiscal space is statistically significant only at the upper part of the conditional government-spending cyclicality distribution, i.e., fiscally procyclical countries.  We also find that for fiscally procyclical countries, the share of foreign currency debt in total government debt, the share of government debt held by nonresidents in total government debt, the share of short-term external debt in total external debt, the ratio of government debt to tax revenue, natural resource dependence, inflation have a procyclical effect, whereas sovereign debt rating, financial depth, and the share of short-term debt in total external debt have a countercyclical effect.