Abstract:The ratios of public debt as a share of gdp of Brazil, Colombia and Mexico were 12 percentage points higher on average during the period 1996-2005 than in the period 1990-1995. Costa Rica's debt ratio remained stable but at a high level; near 50 per cent. Is there reason to be concerned about the solvency of the public sector in these economies? We provide an answer to this question based on the quantitative predictions of a variant of the framework proposed by Mendoza and Oviedo (2007). This methodology yields forward-looking estimates of debt ratios that are consistent with fiscal solvency, for a government that faces revenue uncertainty and can issue only non-state-contingent debt. In this environment, aversion to a collapse in outlays leads the government to respect a "natural debt limit" equal to the annuity value of the primary balance in a "fiscal crisis". A fiscal crisis occurs after a long sequence of adverse revenue shocks, and public outlays adjust to their tolerable minimum. The debt limit also represents a credible commitment to remain able to repay even in a fiscal crisis. The debt limit is not, in general, the same as the sustainable debt, which is driven by the probabilistic dynamics of the primary balance. The results of a baseline scenario question the sustainability of current debt ratios in Brazil and Colombia, while those in Costa Rica and Mexico are inside the limits consistent with fiscal solvency. In contrast, current debt ratios are found to be unsustainable in all four countries for plausible changes to Resumen: Los ratios de deuda pública respecto al pib en Brasil, Colombia y Mé-xico fueron, en promedio, 12 puntos porcentuales más altos durante el periodo 1996-2005 que durante el periodo 1990-2005. El ratio de deuda pública de Costa Rica permaneció estable en un nivel elevado cercano a 50 por ciento. ¿Existe alguna razón para preocuparse por la solvencia del sector público en estas economías? Este trabajo proporciona una respuesta fundamentada en las predicciones cuantitativas de una variante de la metodología propuesta por Mendoza y Oviedo (2007). La metodología produce estimaciones proyectadas hacia el futuro de los ratios de deuda, consistentes con la solvencia fiscal de un gobierno sujeto a incertidumbre respecto a sus ingresos, y que sólo tiene la posibilidad de emitir deuda que no es contingente con el estado de la naturaleza. En ese contexto, la aversión a sufrir un colapso del gasto público induce al gobierno a respetar un "límite natural de deuda" igual al valor anualizado del balance fiscal primario que tendría lugar durante una "crisis fiscal". Este tipo de crisis ocurre cuando se produce una secuencia larga de choques adversos a los ingresos fiscales, y los gastos se ajustan a un mínimo valor tolerable. El límite de deuda también representa un compromiso creíble de repago de la deuda, aun durante el transcurso de una crisis fiscal. En general, el límite de deuda no es igual al nivel sostenible de deuda, el cual es determinado por la dinámica probabilística del bala...

Governments in emerging markets often behave like a "tormented insurer," trying to use non-state-contingent debt instruments to avoid cuts in payments to private agents despite large fluctuations in public revenues. In the data, average public debt-GDP ratios decline as the variability of revenues increases, primary balances and current expenditures follow cyclical patterns sharply at odds with the countercyclical patterns of industrial countries, and the cyclical variability of public expenditures exceeds that of private expenditures by a wide margin. This paper proposes a model of a small open economy with incomplete markets that can rationalize this behavior. In the model a fiscal authority makes optimal expenditure and debt plans given shocks to output and revenues, and private agents make optimal consumption and asset accumulation plans. Quantitative analysis of the model calibrated to Mexico yields a negative relationship between average public debt and revenue variability similar to the one observed in the data. The model mimics Mexico's GDP correlations of government purchases and the primary balance. The ratio of public-to-private expenditures fluctuates widely and the implied welfare costs dwarf conventional estimates of negligible benefits of risk sharing and consumption smoothing.

This paper studies a two country model with economies disaggregated into traded and nontraded sectors and in which investment goods as in practice are produced by combining inputs from all sectors. The model also accounts for nontraded distribution services employed in retailing traded goods to consumers. The results show that the model with multiple input investments outperforms the standard model in which sectoral output also serves as its capital. In particular, it substantially improves (a) the movements of trade balance and relative prices, (b) within country comovements of sectoral and aggregate quantities, and (c) cross-country comovements of output vis-à-vis consumption. Abstract This paper studies a two country model with economies disaggregated into traded and nontraded sectors and in which investment goods as in practice are produced by combining inputs from all sectors. The model also accounts for nontraded distribution services employed in retailing traded goods to consumers. The results show that the model with multiple input investments outperforms the standard model in which sectoral output also serves as its capital. In particular, it substantially improves (a) the movements of trade balance and relative prices, (b) within country comovements of sectoral and aggregate quantities, and (c) cross-country comovements of output vis-à-vis consumption.