Debt spikes, blind spots, and financial stress

Abstract

Are blind spots of public debt spikes sizable? And how do they affect financial stress indicators? This paper tackles these questions empirically, using information from 179 episodes of public debt spikes between 1945 and 2014. We find that large public debt spikes are neither driven by high primary deficits nor by output declines but instead by stock‐flow adjustments. These blind spots in debt dynamics are sizable in both advanced economies and emerging markets and could amount to more than 20% of gross domestic product in the median episode. These public debt spikes increase financial stress indicators significantly, in particular when a large share of public debt is held by domestic commercial banks. Enhanced transparency and better debt forecasting tools could help address financial market tensions resulting from blind spots in debt dynamics.