The fundamentals of sovereign debt sustainability : evidence from 15 OECD countries

We study the sustainability of sovereign debt accumulation in 15 OECD countries using quarterly data from 1980 to 2010 with a focus on how and in what countries debt sustainability changed after the commencement of the Euro Convergence Criteria in 1997 as well as after the financial meltdown in 2007. We define sustainability as the validity of the inter-temporal budget constraint of the government and test a sufficient condition motivated by Bohn (1998) using single-country and pooled regressions. We find evidence that the Euro Convergence Criteria contributed to the sustainability of debt accumulation. Further, while the yield spreads suggest the debt crisis is a problem of the southern Euro countries, we find a lack of debt sustainability for Greece, Portugal and France but not for Italy and Spain. In terms of debt sustainability, the crisis adversely affected primarily stand-alone countries rather than members of the European Monetary Union. Nevertheless, yield spreads increased more in the southern countries of the monetary union than in stand-alone countries. Our results support the view that countries within a monetary union are more prone to investors' sentiments than stand-alone countries.