The Austerity Threshold

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.