Fiscal Anatomy of Two Crises and an Interlude

IMF Working Papers, June 2, 2023

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Title: Fiscal Anatomy of Two Crises and an Interlude
Authors: Xuehui Han, Paolo Mauro, John Ralyea
Date: June 2, 2023
Series: Working Paper No. 2023/117
Summary point: The Global Financial Crisis (GFC) and the COVID-19 pandemic are associated with the largest increases in public debt ratios since World War II. The paper decomposes unexpected changes in debt ratios into surprises in economic growth, interest costs, policy measures, and other factors.

Decomposes unexpected changes in public debt ratios into contributions from:
- surprises in economic growth,
- interest costs,
- policy measures recorded in the public deficit,
- other factors.
Application: Comparison across two crisis episodes (GFC and COVID-19) and a decade-long interlude (2010-19).

Both crises (GFC and COVID-19) produced the largest increases in public debt ratios since World War II.
During both crises, lower-than-expected output contributed the most to higher-than-expected debt ratios.
Fiscal policy measures recorded in the public deficit were similar in the two episodes.

The decade-long interlude (2010-19) was analyzed against a normative scenario in which debt ratios were expected to decline.
Instead of declining as foreseen, debt ratios remained stable on average during 2010-19.
Drivers of this deviation from the normative scenario included:
- interest rates turned out lower than expected,
- policy adjustment turned out lower than expected,
- in some countries, economic growth turned out lower than expected.

Fiscal policy measures as recorded in the public deficit played a similar role across the two crisis episodes, implying comparable fiscal responses as measured in deficits.
The dominant role of output surprises in raising debt ratios during crises highlights the importance of macroeconomic stabilization for public debt dynamics.
The interlude results point to the importance of accurately assessing interest rate trajectories, policy adjustments, and growth prospects when forecasting debt paths.