The Limits of Limitless Debt

Kent Osband Valerio Filoso (), Capasso Salvatore () and Valerio Filoso ()
Additional contact information
Kent Osband Valerio Filoso: Institute for Studies on the Mediterranean (ISMed), CNR.
Capasso Salvatore: Università di Napoli Parthenope, ISMed-CNR, and CSEF., https://csef.it/people/salvatore-capasso/
Valerio Filoso: University of Naples Federico II, and Institute for Studies on the Mediterranean (ISMed), CNR.
Authors registered in the RePEc Author Service: Valerio Filoso

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: How worrisome are mounting sovereign debt-to-GDP ratios? Many economists profess little concern. Debt stocks are irrelevant to sustainability in standard macro models, while low real interest rates testify to lender optimism. Furthermore, the debt is mostly in fiat currency, which eases rollover. Yet historical evidence (Reinhart and Rogoff, 2009) shows that high sovereign debt is prone to default and that credit spreads are often trailing indicators. This paper offers a simple way to model the trade-offs. On the one hand, it acknowledges that large debt overhangs tend to raise default risks. On the other hand, it allows sovereigns to roll over debt regardless of long-term fiscal solvency. The combination allows credit spreads to stay very low for decades yet eventually spiral out of control and trigger default. Hence, neither the reassurance of low spreads nor the alarm from growing overhang should automatically prevail. To illustrate the trade-offs, we review the ebb and flow of US sovereign debt burdens since World War II. Between record peacetime debt-to-GDP ratios and weakened fiscal discipline, an exemplary double-or-triple-A credit rating for the US no longer seem justified.

Keywords: bond market; bond interest rate; credit spreads; sovereign debt; sovereign debt default; debt management surprise (search for similar items in EconPapers)
JEL-codes: D84 G12 H63 (search for similar items in EconPapers)
Date: 2022-12-29
New Economics Papers: this item is included in nep-his
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.csef.it/WP/wp662.pdf (application/pdf)

Related works:
Journal Article: The limits of limitless debt (2024)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:sef:csefwp:662

Access Statistics for this paper

More papers in CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy Contact information at EDIRC.
Bibliographic data for series maintained by Dr. Maria Carannante ().