Assessing Debt Sustainability: modelling challenges and the way forward, 30 November 2023
The ESM 2023 Debt Sustainability Seminar (DSA) seminar brought together debt sustainability experts from policy institutions and academia to explore how to combine behavioural and empirical models to assess debt sustainability. Here are the main themes that emerged from the discussions:
- Using stochastic fan charts helps define the range of possible outcomes for the debt path, and complements scenario analysis by modelling uncertainty over the medium term.
- Experts should pay particular attention to the sensitivity of the fan charts to the assumptions on debt drivers and the challenges of capturing large shocks.
- Developing an assessment methodology based on the stochastic DSA remains a challenge. Some progress has been made by identifying key variables and back-testing their predictive power of debt distress episodes through Receiver Operating Characteristic curves.
- Advantages of structural (e.g. DSGE model) models include their ability to incorporate feedback loops and address general equilibrium considerations. They also allow for the creation of internally consistent scenarios.
- The drawbacks of using structural models involve higher complexity and lower tractability of these models, along with a lack of granularity in modelling financing structures and interest payments.
Using the DSA as a policy instrument
The use of the DSA as a tool to shape fiscal behaviour (normative DSA) is distinct from its use to assess sustainability risks (positive DSA).
Reverse engineering could materialize both in normative DSAs for policy use and positive DSAs, rendering their assessment less informative. To limit this risk, the use of judgment needs to be appropriately constrained and disciplined by supportive analysis.
Last but not least, debt sustainability is not an observable concept, and the DSA is only as good as its underlying assumptions. For this reason, it is important to make the DSA methodology and assumptions transparent and to acknowledge limitations.
The DSA needs to be well-communicated, especially when it comes to the nature of risks assessed, any uncertainties in the analysis, and its implications for policy. Ideally, the DSA needs to be intelligible to various audiences (including the common public), and differentiate high-level messaging vs. technical details.
You can find in the following links detailed summaries of the technical sessions: