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February 03, 2010

A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates – A New IMF Technical Note

PFM Blog has recently interviewed Julio Escolano, Deputy Division Chief of the IMF Fiscal Affairs Department’s Fiscal Policy and Surveillance Division and author of a new IMF Technical Note. 

PFM Blog: You have recently published a note in the IMF Technical Notes and Manuals (TNM) series. What is this note about?

Julio Escolano: The title of the note is “A Practical Guide to Public Debt Dynamics, Fiscal Sustainability, and Cyclical Adjustment of Budgetary Aggregates.” It can be downloaded from the IMF webpage at http://www.imf.org/external/pubs/ft/tnm/2010/tnm1002.pdf. The note discusses the methodology that is used to analyze the dynamics of public debt and common indicators of fiscal sustainability as well as of the underlying budgetary position of a country. It is meant to be used by fiscal economists as a small manual or “vade mecum” of formulas and relationships among fiscal variables. These are tools and methodologies are often not found in standard economics manuals, rather they are scattered throughout different papers, manuals, articles, and in some cases, only in the “lore” or “folk wisdom” of specialized economists or public finance practitioners. Thus, it can be useful to have them compiled in a compact presentation and with consistent notation and formulas. In fact, the idea and encouragement to write this note come from Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department, one evening that we were working in the office until late. We found that Carlo, other colleagues, and I had been independently deriving the same formulas for some note we were working on—nobody remembered these formulas off the top of our head. (Felicitously, we all came out with the same results.) I guess we would have gone home earlier that evening if we had had this note then.

The coverage of topics is, of course, far from exhaustive. At this point, as its title indicates, the note focuses on debt dynamics and budget indicators to correct budget aggregates for the business cycle and inflation. However, I plan to update it from time to time to cover additional topics that may prove useful, based on our evolving experience.

PFM Blog: Can you give some examples of how the material in the note can be useful for fiscal economists?

J.E.: The recent crisis is having a dramatic impact on budget positions and debt levels in many economies. As a consequence, a lot of economists and analysts not familiar with public finances may need to refresh or learn quickly the basic methods used in fiscal analysis and debt sustainability assessments. This note can be used as a handy reference for that. For example it contains the basic formulas used for forecasting the dynamics of the debt-to-GDP ratio under different growth, inflation, and interest rate assumptions; or those necessary to adjust budget magnitudes for the cycle according to different methodologies, from the back-of-the-envelope calculations to quite sophisticated ones. It also discusses the rationale behind these methodologies, as well as practical advice on their application, common parameter values, etc.


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