Understanding Fiscal Limits and Debt in the Developing Economies of Central America and the Caribbean

This study uses simulations of state dependent distributions of fiscal limits for eighteen (18) economies within Central America and the Caribbean to better understand governments’ ability to service its debt, arising from endogenously determined dynamic Laffer curves. Using a small open economy model to simulate macroeconomic fundamentals and fiscal policy interactions, the empirical findings produced results not previous available for these economies, showing varying and wider distribution of fiscal limits for the open economy model subject to term of trade shocks, indicating that terms of trade volatility impacted the ability of state economies in servicing their debt. It is therefore prudent that policymakers and central bankers consider models that incorporate the use of trade and its volatility, as a robust way of more accurately determining fiscal limits which are a critical component in better understanding governments’ ability to service its debt.