On the Probabilistic Approach to Fiscal Sustainability: Structural Breaks and Non-Normality

This paper modifies several assumptions in the probabilistic approach to fiscal sustainability proposed by Celasun, Debrun, and Ostry (2007). First, we allow for structural breaks in the vector autoregression model for the macroeconomic variables. Second, in the Monte-Carlo simulations, we draw directly from the empirical distribution of the shocks instead of drawing from a normal distribution, thus allowing for asymmetries and thick tails. Third, we circumvent the use of a fiscal reaction function by focusing attention instead on debt-stabilizing balances, to produce more “agnostic” debt projections. The paper illustrates how these methodological modifications have significant impacts on the results for specific country cases.