Assessing fiscal sustainability under uncertainty

Abstract

Unlike conventional fiscal sustainability assessments, the value-at-risk (VAR) approach developed in this paper explicitly captures the contribution of key risk variables to public sector vulnerability. In an illustrative application to Ecuador, the VAR approach confirms a significant risk of government financial failure stemming from the volatility and co-movements of the exchange rate, interest rates, oil prices, and output. Although dollarization has helped to attenuate fiscal vulnerability, the volatility of sovereign spreads and that of oil prices remain major sources of risk for Ecuador's public sector. The paper concludes with a discussion of policy implications, an evaluation of the methodology, and suggestions for future research.