Discussion paper

DP15282 Debt Sustainability in a Low Interest Rate World

Conditions of secular stagnation—low output growth g and low interest rates r—have
counteracting effects on the cost of servicing public debt, r − g. Using data for ad-
vanced economies, we document that r is often less than g, but r − g exhibits substan-
tial variability over the medium-term. We build a continuous-time model in which
the debt-to-GDP ratio is stochastic and r < g on average. We analytically characterize
the distribution of the debt-to-GDP ratio, showing how two candidate explanations
for low interest rates, slower trend growth and higher output risk, can lower the debt-
to-GDP ratio. When the primary surplus is bounded above, we characterize a fiscal
limit, above which default occurs, and a debt tipping point, above which the pub-
lic debt is on an unsustainable path, but default does not occur immediately. Slower
trend growth and higher output risk can paradoxically improve debt sustainability. A
conservative calibration suggests a fiscal limit for the US of 184 percent of GDP and a
tipping point of 115 percent of GDP.


Sergeyev, D and N Mehrotra (eds) (2020), “DP15282 Debt Sustainability in a Low Interest Rate World”, CEPR Press Discussion Paper No. 15282. https://new.cepr.org/publications/dp15282