On the Failure to Reach the Optimal Government Debt Ceiling

Abel Cadenillas  and Ricardo Huamán-Aguilar

Abstract

We develop a government debt management model to study the optimal debt ceiling when the ability of the government to generate primary surpluses to reduce the debt ratio is limited. We succeed in finding a solution for the optimal debt ceiling. We study the conditions under which a country is not able to reduce its debt ratio to reach its optimal debt ceiling, even in the long run. In addition, this model with bounded intervention is consistent with the fact that, in reality, countries that succeed in reducing their debt ratio do not do so immediately, but over some period of time. To the best of our knowledge, this is the first theoretical model on the debt ceiling that accounts for bounded interventions.

Keywords: debt crisis; government debt management; optimal government debt ceiling; government debt ratio, stochastic control; decision analysis; risk management

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https://www.mdpi.com/2227-9091/6/4/138