From Fiscal Policy to Investment
Paper Session
Sunday, Jan. 3, 2027 8:00 AM - 10:00 AM (EST)
- Chair: Kenneth Rogoff, Harvard University
When Less is More: Debt Reduction and Investment
Abstract
The past two decades have been marked by extraordinary government debt runups and private investment weakness. Will efforts to rein in government debt unleash private investment? Using both country-level and firm-level data, we document three key findings. First, government debt reductions are associated with significantly higher private investment--and investment rises most when government debt reduction avoids macroeconomic disruptions. Second, government debt reductions crowd in firm-level investment, especially among firms with weak cash flow and when credit conditions improve. Third, firm investment is less responsive to credit constraints during periods of large government debt reduction--suggesting that loosening credit constraints are a mechanism for the country-level result. The country-level results are robust to alternative samples and specifications. The firm-level results are robust to alternative country samples, various proxies of credit constraints, and controlling for macroeconomic channels that could influence firm investment when government debt declines--such as strong GDP growth or an improvement in sovereign credit ratings.From Debt Reset to Growth Onset? Sovereign Debt Restructuring and Firm Performance in Developing Countries
Abstract
Leveraging a unique dataset that combines country-level information on debt restructuring with firm-level data from the World Bank Enterprise Surveys (WBES) spanning from 2004 to 2023, we analyze the effects of debt restructuring on firm sales growth. Using recent advancements in difference-in-differences estimation to account for the staggered implementation of restructurings, we find that sovereign debt restructuring increases firm performance by 5–9 percentage points, with stronger effects for private, domestically-owned firms and those reliant on public and financial services. The impact varies by debt type (domestic or external), creditor composition, and implementation speed. Swift external restructurings led by official creditors, such as the Paris Club, yield the most substantial positive effects, whereas other types of restructurings show no significant impact on private sector growth.The Austerity Threshold
Abstract
We introduce a new indicator of fiscal capacity—the “austerity threshold”: the debt-to-GDP level above which the government must raise fiscal surpluses to ensure debt safety. In a model with realistic risk premia, nominal rigidities, and an intermediary sector, calibrated to the U.S., we estimate this threshold at 189%. We highlight the roles of safety premia and intermediation-driven convenience yields. The threshold varies with the source of surpluses: spending cuts reduce inflation and allow low interest rates, while tax increases distort labor supply and raise inflation. Uncertainty over the austerity regime – spending cuts or tax increases – sharply lowers fiscal capacity. The expected austerity regime affects asset prices and macro outcomes even when debt-to-GDP is well below the threshold.Discussant(s)
Sarah Zubairy
,
Texas A&M University
Laura Alfaro
,
Inter-American Development Bank
Graciela Kaminsky
,
George Washington University
Eric Leeper
,
University of Virginia
JEL Classifications
- E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
- O1 - Economic Development