A Stochastic Indicator for Sovereign Debt Sustainability

We propose a stochastic indicator to assess government debt sustainability. This indicator combines the effect of economic uncertainty - represented by stochastic simulations of interest and growth rates - with the expected fiscal response, which provides information on the long-term country-specific attitude towards fiscal sustainability. We apply our framework to postwar data for nine OECD countries and find that our indicator - the potential increase in debt in bad states of the world - distinguishes countries that have sustainability concerns (Italy, Spain, Portugal, and Iceland) from those that do not (the United States, the United Kingdom, the Netherlands, Belgium, and Germany).