Probabilistic Sustainability of Public Debt: A Vector Autoregression Approach for Brazil, Mexico, and Turkey

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Abstract: This paper examines the sustainability of fiscal policy under uncertainty in three emerging market countries—Brazil, Mexico, and Turkey. For each country, we estimate a vector autoregression that includes fiscal and macroeconomic variables. Retrospectively, a historical decomposition shows by how much debt accumulation reflects unsustainable policy, adverse shocks, or both. Prospectively, Monte Carlo techniques reveal the primary surplus required to keep the debt-GDP ratio from rising in all but the worst 50, 25, and 10 percent of circumstances. Such a value-at-risk approach presents a clearer menu of policy options than do frameworks currently in use. [JEL D61, E61, E62].