Taming government debt—it can be done, but it ain’t easy

IMF Blog, September 25, 2013

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Taming government debt—it can be done, but it ain’t easy

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Bibliographic details

• Authors: Helge Berger, Justin Tyson
• Published: September 25, 2013

Overview

• Authors: Helge Berger, Justin Tyson
• Date: September 25, 2013
• Central message: Government debt in advanced economies, elevated after the global economic and euro area crises, will need to be reduced. There is no single “magic” safe debt ratio; reduction comes with trade-offs because cutting spending or raising taxes risks lowering growth and employment in the short term.

The ins and outs of debt reduction

• Key mechanisms that reduce debt:
  • Higher economic growth increases government revenues, reduces unemployment benefits, and lowers the debt-to-GDP ratio.
  • Fiscal consolidation (reducing government deficits) is the alternative when rapid growth is not available.
• Constraints and complications:
  • Current environment features cautious household spending, stretched bank balance sheets, low inflation, and limited prospects for quickly conjuring high growth.
  • Attempts to raise inflation to reduce real debt could backfire if inflation expectations are not well anchored.
  • Fiscal consolidation in a weak-growth, high-debt context can initially increase the debt-to-GDP ratio because lower demand reduces revenues and the GDP denominator.
  • Lower borrowing costs from credible consolidation rarely offset the short-run demand loss.
  • If a country is losing market access, fiscal effort may need to be front-loaded.
• Empirical findings:
  • Fiscal balances are a key driver of changes in debt-to-GDP ratios, but growth matters strongly.
  • Debt reductions tend to be larger when growth rates are high and interest rates are low.
  • Debt reversals are fewer and smaller when both growth is low and interest rates are high.
  • Only 26 percent of fiscal consolidation efforts (defined as a large adjustment in fiscal balances ignoring interest rate payments) were successful when growth is below a country’s historical average.
  • When growth is above average, the success rate of consolidation increases to 41 percent.

Past experience — reducing debt when growth is low is possible

• Sample: 26 episodes of debt reductions in advanced economies since 1980.
• Findings from these episodes:
  • Growth and fiscal effort were the main drivers of successful debt reductions.
  • Some episodes achieved large debt reductions despite starting conditions of anemic growth and very high debt burdens.
  • Common factors in successful episodes:
  • Early start to consolidation and persistence through initial weak growth.
  • Continued consolidation as growth recovered, allowing debt to fall.
  • Fortuitous improvements such as falling short-term interest rates, currency depreciation, and solid export growth—channels less available in the current near-zero interest rate, slow global trade environment.

Policy implications and recommendations

• Pace and design:
  • Consolidation should generally be gradual where possible, supported by credible medium-term plans to spread adjustment over time.
  • If a country is close to losing market access, stronger, front-loaded consolidation may be unavoidable.
• Complementary measures:
  • Enact measures now that increase medium-term growth, including structural reforms.
  • Consider privatization of government assets in some economies to reduce the need for fiscal consolidation.
• Expectations:
  • For most countries, bringing down the public debt-ratio will require a sustained fiscal effort for a number of years.
  • Perseverance with credible plans and strong budget institutions improves the chances that consolidation will pay off over time.

Source: Taming government debt—it can be done, but it ain’t easy — Helge Berger, Justin Tyson; September 25, 2013.

Content in this bundle

• Staff Discussion Note
  • Staff Discussion Note (Markdown version)
  • Staff Discussion Note (PDF)

References

• https://www.imf.org/wp-content/uploads/2013/09/figure-1-dev-in-gross-debt-and-structural-balance-in-adv-economies.jpg
• https://www.imf.org/wp-content/uploads/2013/09/figure-2-avg-annual-contributions-to-reductions-in-debt-under-diff-macro-conditions.jpg
• https://www.imf.org/wp-content/uploads/2013/09/figure-3-components-of-major-debt-reductions-in-adv-economies.jpg
• https://www.imf.org/wp-content/uploads/2013/09/figure-4-evolution-of-key-variables-through-deficit-reduction.jpg