When Should Public Debt Be Reduced?
Staff Discussion Notes, June 1, 2015
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Bibliographic details
- Authors: Jonathan David Ostry, Atish R. Ghosh, Raphael A Espinoza
- Published: June 1, 2015
- Series: Staff Discussion Notes
- DOI: https://doi.org/10.5089/9781498379205.006
Main argument
- For countries with ample fiscal space (little risk of encountering a fiscal crisis), raising distortionary taxes merely to bring the debt down is a treatment cure that is worse than the disease.
- High public debt is costly, but it is a sunk cost only made worse by efforts to pay down the debt through distortionary taxation.
- Living with the debt is the welfare-maximizing policy in such circumstances.
Key findings
- Normative anchors (such as 60 percent of GDP) should not automatically dictate debt reduction when fiscal space is ample.
- Decisions about whether to increase debt to finance a big public investment push must account for the additional servicing costs and the associated distortionary taxation from the resulting buildup of public debt.
- Golden-rule considerations remain salient when evaluating public investment versus debt servicing.
Policy recommendations
- Do not raise distortionary taxes solely to reduce existing public debt in economies with ample fiscal space.
- When considering a large public investment push funded by borrowing, explicitly account for:
- the additional debt-servicing costs, and
- the distortionary taxation required to service that additional debt.
- Apply golden-rule principles to ensure public investment returns justify the additional borrowing and servicing burden.
Considerations and conceptual points
- Debt reduction should be guided by country-specific fiscal space and crisis risk, not by universal numeric anchors alone.
- The welfare-optimal choice can be to "live with the debt" rather than incur welfare losses through distortionary fiscal consolidation.
- The tradeoff between public investment benefits and the costs of increased debt servicing is central to the decision framework.
When Should Public Debt Be Reduced? — Jonathan David Ostry, Atish R. Ghosh, Raphael A Espinoza; June 1, 2015.