A Future with High Public Debt: Low-for-Long Is Not Low Forever

IMF Blog, April 20, 2021

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Canonical URL: A Future with High Public Debt: Low-for-Long Is Not Low Forever

Authors: Marcos Chamon, Jonathan D. Ostry
Date: April 20, 2021
Core observation: Many countries face a combination of high public debt and low interest rates; this was true in advanced economies before the pandemic and has intensified afterward, with a growing number of emerging market and developing economies experiencing negative real rates on government debt.
Policy context: The IMF has urged countries to spend as much as they can to protect the vulnerable and limit long-lasting economic damage, emphasizing well-targeted spending and greater prioritization in emerging market and developing economies.

Negative real rates: A growing number of emerging market and developing economies are enjoying a period of negative real rates—the interest rate minus inflation—on government debt.
Growth versus interest comparisons: The chart referenced compares the Consensus Forecast for growth in the G7 economies with the real interest rate (10-year bond yield minus inflation) in 2030; forecasts imply growth rates well in excess of real interest rates for all G7 countries except Italy.
Debt limit usage: Model-based estimates of debt limits (reflecting market conditions after the Global Financial Crisis but prior to COVID-19) show how much of the estimated fiscal space (debt limit minus 2007 debt) was used from 2007 to 2019 (blue bars) and how much is projected to be used from 2019 to 2025 (orange bars).
Constraint risk: For some countries, remaining fiscal space would not allow a response of a size comparable to that deployed following the Global Financial Crisis or COVID-19—potentially constraining action in the event of another major shock.

Permanence unlikely: The authors’ answer to whether borrowing will remain cheap for the entire horizon relevant for fiscal planning (which they characterize as the indefinite future) is "no."
Risk of abrupt shifts: History contains numerous episodes of abrupt upticks in borrowing costs once market expectations shift; this risk is particularly relevant for emerging market and developing economies with already high debt ratios.
Market-driven adjustments can be sudden: Theory and history suggest investors penalize countries quickly when they worry fiscal space may run out; market adjustments are not necessarily gradual and may occur before growth recovers.

Scenario 1: Interest rates remain low in advanced economies even if debt continues to increase.
- Implication: No need to worry about debt or steady (non-accelerating) deficits; the debt ratio would continue to rise but eventually stabilize at a higher level.
Scenario 2: Interest rates are low at given debt levels, but would not remain low if debt were to rise significantly.
- Implication: Most G7 countries can run a primary deficit close to 2 percent of GDP while still stabilizing their debt ratios; they effectively have a "free lunch" provided deficits remain below the debt (ratio)-stabilizing level.
Scenario 3: Interest rates are low but could adjust, perhaps abruptly.
- Implication: There is a case for using favorable conditions to reduce debt and rebuild buffers; even a small perceived risk can justify preemptive concern because the costs of forced adjustment can be large.

Near-term fiscal stance: It is self-defeating to target a higher budgetary balance while the pandemic persists; do not rush to tighten before the recovery is firmed up.
Medium-term anchoring: Countries should plan now to anchor expectations for a riskier future where borrowing costs might be significantly higher, especially emerging market and developing economies.
Differentiation by space:
- Advanced economies with ample fiscal space may not need to worry much immediately.
- Countries with very high debt—where the reasons for low borrowing costs are imperfectly understood—might need to take anchoring insurance (i.e., proactively reduce vulnerabilities).
- Emerging market and developing economies, likely facing more binding fiscal constraints, may need to adjust sooner (but still not before the recovery is firm).
Fiscal frameworks: There is a need to rethink fiscal anchors—rules and frameworks—to take account of historically low interest rates and uncertainty about their persistence.
Communication and plans: Laying out plans to anchor expectations should be done today, because fiscal space is uncertain and market expectations can turn abruptly.

Prudential baseline: Treat the likelihood that borrowing costs might rise significantly as non-negligible and plan fiscal policy to anchor expectations for a riskier future.
Urgency: While immediate fiscal support remains essential, all countries should develop credible medium-term plans that signal sustainability and reduce the risk of abrupt market repricing.

IMF Blog post: "A Future with High Public Debt: Low-for-Long Is Not Low Forever" by Marcos Chamon and Jonathan D. Ostry, April 20, 2021.

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_spn1011 — Executive Summary
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