1) The document discusses the distinction between fiscal sustainability and debt sustainability. Fiscal sustainability refers to a fiscal stance that is unlikely to lead to a roll over crisis, while debt sustainability means public debt itself is unsustainable even after returning to fiscal sustainability, requiring debt restructuring. 2) It compares the relative costs of adjusting the primary balance orthodoxly versus restructuring debt. Adjusting the primary balance risks larger output costs from demand effects, while debt restructuring risks a default tax, wealth loss for domestic debt holders, and uncertainty about the sufficiency of restructuring and return to markets. 3) Restructuring debt also risks reputational costs that depend on the amount of net present value loss imposed on debt

1. SOVEREIGN DEBT CRISES:
PREVENTION AND MANAGEMENT
ROME DECEMBER 10, 2018
CARLO COTTARELLI
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2. FISCAL AND PUBLIC DEBT SUSTAINABILITY
We need to clarify the distinction between fiscal sustainability and
debt sustainability:
Fiscal sustainability: a fiscal stance, as defined as, at a minimum,
by a certain path of the primary surplus as a ratio to GDP and a
related path for the public debt ratio, is sustainable if it is unlikely
to lead to a roll over crisis. An unsustainable fiscal position can be
made sustainable by strengthening the primary balance.
Debt sustainability: not only the fiscal position is unsustainable but
also that public debt is unsustainable is returning to fiscal
sustainability necessarily requires a restructuring of public debt.
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3. Relative costs of different policy
options
Orthodox (primary balance)
adjustment
Debt restructuring
Output costs through demand
effects arising from improvement in
primary balance
Larger primary balance increase to
the level needed to bring down debt
to the desired level
Some primary balance increase
needed to at least stabilize the debt
ratio after the restructuring (it could
be large if: (i) the initial primary
deficit is large; or (ii) there is no
access to official financing after the
restructuring)
Output costs through demand
effects arising from default tax None
Wealth loss for residents equal to the
NPV cut times the share of domestic
residents’ holdings
Supply side effects arising from
distortionary taxes/lower
productive spending needed to
raise the primary surplus
Arising from keeping the primary
surplus at a higher level during the
period of debt reduction and later at
the level needed to stabilize the debt
ratio at the desired level
Arising from keeping the primary
surplus at a higher level until market
return and later at the level needed
to stabilize the debt ratio at the
desired level
Uncertainty Arising from the risk of “reform
fatigue” and related policy
slippages.
Arising from uncertainty on (i)
whether the debt restructuring was
sufficient; and (ii) the timing of return
to market
Reputational costs None Depends on amount of NPV loss 3

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