Oviedo, P. Marcelo

WP #06040, November 2006

In financial and economic policy circles concerned with public debt in developing countries, a rising debt-GDP ratio is interpreted as a signal of overborrowing, warning of debt defaults if strong fiscal corrections are not adopted in time. This paper shows why this interpretation is incorrect by building a simple model of fiscal policy in which upward-sloping debt paths are observed even though the probability of default is ``almost surely" equal to zero.

JEL Classification: E62, F34, F37, H63

Keywords: public debt, fiscal policy, debt sustainability, debt limits

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