Assessing the stochastic stability of public debt: the case of Austria

This paper characterizes the long-run distribution of Austrian public debt using a Markov chain model of the debt-GDP ratio and several key macroeconomic variables. We apply Bayesian techniques to estimate the transition probabilities of the model which allows to incorporate information from other countries. Based on the model, we argue that the historical record of Austrian fiscal policy is consistent with a stable long-run distribution of the debt-GDP ratio with an expected value close to the 60% threshold of the Maastricht treaty. Our results suggests that the strong increase in the debt-GDP ratio in the aftermath of the recent financial crisis should be seen as a transitory tail event rather than as a sign of long-run unsustainability. However, we also show that the existence of a stable long-run distribution depends on a continuing tendency of fiscal policy to “lean against debt” by reducing the primary deficit in face of rising debt. Finally we assess how exogenous shocks to the primary deficit and real GDP growth affect the model-implied distribution.