Optimal correction of the public debt and measures of fiscal soundness

This paper derives the optimal response of the primary budget balance to changes in the public debt as a share of gross domestic product (GDP) in a stochastic model of debt. Under the optimal solution, the surplus reactivity to the debt-GDP ratio is independent of the debt ratio itself, but its size depends on the degree of uncertainty surround-ing the impact of fiscal policies. We characterize the prop-erties of the optimal control policy by proposing different metrics that may be used to assess fiscal soundness and as early warning indicators of fiscal imbalances.