Banque de France Financial Stability Review on Public Debt—Special Address to Panel Discussion

April 21, 2012

By Christine Lagarde
Managing Director, International Monetary Fund
Washington, April 21, 2012

As prepared for delivery

Good evening. It’s a pleasure to be here. I would like to thank my good friend Christian Noyer for inviting me. Governor Noyer is a gifted and devoted public servant, and I admire him greatly for his deft economic stewardship during an incredibly difficult time.

I’m also deeply impressed by the luminaries who contributed to this Review, including those on the panel today. A great amount of work, a great amount of wisdom.

As we all know, the very high level of debt is one of the greatest economic challenges facing nations today, especially the advanced economies.

This is what I want to talk about today—three aspects in particular:

  • First, the nature of the challenge.
  • Second, what countries should do in the short run.
  • Third, more medium-term fiscal challenges.

Nature of the challenge

Let me start with the challenge. Among the advanced economies, the ratio of debt to GDP is expected to hit 109 percent next year, up from 75 percent in 2007. This is the highest recorded debt ratio in more than 130 years, with the sole exception of the short-lived debt buildup after the Second World War.

How did we get here? Mainly because of the global financial crisis. The direct fallout from this crisis explains two-thirds of the rise in the debt ratio among the G20 advanced economies. For sure, this fiscal accommodation was sorely needed, as the jump in deficits helped counteract the fall in private demand. In such an extreme situation, it was “all hands on deck” in terms of policy options.

But we can’t pin the blame for our fiscal woes on the crisis alone. The advanced countries entered the crisis in the worst shape in decades—the public debt ratio was already at a postwar peak by 2007. Countries simply did not use good times well. They did not sow in good times so they could harvest in bad times.

As Aesop said a long time ago: “Affairs are easier of entrance than of exit; and it is but common prudence to see our way out before we venture in”. Wise words.

Now we need a credible exit strategy to bring down debt over the medium term. High public debt is a drag on the already-low growth prospects of advanced economies. And we risk renewed turmoil if we do not act with sufficient vigor, especially since countries with high debt are at the mercy of financial markets and self-fulfilling prophecies.

If we do nothing, it’s going to get a lot worse in the years ahead. IMF analysis shows that the median increase in pension and healthcare spending in advanced economies over the next 40 years is 6¾ percent of GDP. We can’t put corrective action off forever.

Fiscal policy in the short run

So how should we see our way out?

Well, my first point is that we should not be too hasty. A global undifferentiated rush to austerity will ultimately prove self defeating. This is especially true in current circumstances. Recent IMF research finds that fiscal multipliers are quite large in downturns, meaning that an overly-aggressive adjustment today will hurt growth, and might actually also raise public debt ratios.

So what should countries do? The answer will be different depending on circumstances. Countries that are under extreme pressure from markets have no option but to cut deficits today, often sharply. On the other hand, countries with fiscal space could consider slowing the pace of adjustment today, to reduce risks to growth. If growth is slower than expected, countries that can do so should let automatic stabilizers operate freely, letting the deficit rise.

We certainly try to apply this flexibility in the programs we support. In some cases, there is simply no alternative to large upfront fiscal tightening. But to the extent possible, we have sought longer adjustment horizons, supported by greater financing. We also seek to complement fiscal adjustment efforts with reforms to boost growth, such as opening up closed professions.

Fairness is also important. Fiscal adjustment usually means taking tough decisions. But it should be done in a way that protects the poor and most vulnerable, and shares the burden fairly across the population. Adjustment is unlikely to be sustained for long if it is seen as inequitable.

Medium term challenges

Let me know turn to more medium-term fiscal issues, the need for credible medium-term consolidation plans. This is a daunting challenge. Among the advanced economies, the average adjustment needed to bring debt back to 60 percent of GDP by 2030 is 8 percent of GDP.

Here, I’m afraid that countries need to do better than they have so far. Among these countries, Japan and the United States have the largest distance to travel, and so need the greatest effort. Both need a stronger push to fix their public finances, including by curbing the growth of entitlement spending and raising more revenue.

One thing we’ve found is that getting the job done is easier if the proper fiscal institutions are in place. By that I mean the nuts and bolts of budgeting—the laws, procedures, rules, and conventions. There’s certainly room for improvement here—I’m thinking of areas like comprehensive and timely fiscal reporting, more effective medium-term budget frameworks, and better management of fiscal risks. Fiscal rules can also build credibility, confidence, and consensus around fiscal plans. The IMF stands ready to help countries strengthen their fiscal institutions.

On a related note—fiscal plans are only as good as the data that underlie them. The IMF is well aware of data limitations and inconsistencies across countries in public sector debt statistics. So we are stepping up our game in this area, developing—along with eight other international organizations—a strategy based on standard definitions and practical guidance, supported by technical assistance and hands-on training.

One final point—another lesson from the crisis is that fiscal sustainability can be directly tied to financial sector stability. We know of how banks can hurt sovereigns by passing on debt or contingent liabilities. We know how sovereigns can hurt the banks that hold their debt.

So we need to insulate the sovereign from the financial sector. This means better financial sector regulation and supervision—to make the system safer and more secure, less prone to taking risky bets where gains are pocketed and the bill for losses is sent to the taxpayer. It also means getting the financial sector to pay its fair share.


I will leave you with one simple message—policymakers must get to grips with their fiscal and financial stability challenges. Good progress has been made in many countries, but none have fully resolved their fiscal dilemmas. They must do so urgently, not shying away from difficult decisions, but always in a spirit of harmony and cooperation.

In this regard, the Financial Stability Review and today’s discussion are extremely important. They provide an excellent opportunity to explore the issues in depth, and to learn from each other. I look forward to the outcomes—and I assure you these outcomes matter a great deal for our collective economic future.

Thank you.


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