## An Argument for Paying Down Public Debt _IMF Blog, August 26, 2016_ ## Source details **Canonical URL:** [An Argument for Paying Down Public Debt](https://www.imf.org/en/blogs/articles/2016/08/26/an-argument-for-paying-down-public-debt) ## Other formats - [Markdown version](/en/blogs/articles/2016/08/26/an-argument-for-paying-down-public-debt/index.md) - [Structured JSON version](/en/blogs/articles/2016/08/26/an-argument-for-paying-down-public-debt/index.json) - [Bundle manifest](/en/blogs/articles/2016/08/26/an-argument-for-paying-down-public-debt/bundle-manifest.json) ## Bibliographic details - Authors: Vitor Gaspar, Julio Escolano - Published: August 26, 2016 --- ### Overview - Authors: Vitor Gaspar, Julio Escolano - Publication date: August 26, 2016 - Question addressed: What should governments do about high public debt-to-GDP ratios when viewed from an optimal tax smoothing perspective (abstracting from macroeconomic/business cycle considerations)? ### Context and motivation - In advanced economies, the debt-to-GDP ratio has reached the highest level on record since 1950. - The increase in debt was particularly pronounced since the beginning of the Great Recession due to government rescues of the financial system and stimulus measures, resulting in a substantial increase in general government’s liabilities. - Characteristics of the era noted: low inflation, low growth, and bond yields at historical lows. - Trade-off emphasized: deleveraging is difficult in this environment, but fiscal policy has been called upon to play a more active role to head off a new mediocre of subpar growth and extremely low inflation. ### Literature connection - Reference to IMF colleagues Ostry, Ghosh, and Espinoza: - Their argument: countries can live with high debt under certain assumptions (for example, continuous access to financing). - They analyze interaction between tax smoothing and productive public investment in determining optimal policy. - Main result: high public debt ratios imply higher tax rates and are bad for standards of living (or growth), but after a sharp debt increase taxes should be raised only to stabilize the debt ratio; pushing taxation further to reduce debt is not optimal because the excess burden of taxation increases more than proportionally to the tax rate. - Policy note: governments should be opportunistic in reducing public debt (e.g., with privatization receipts, licensing royalties, or economic booms yielding exceptionally high revenues). ### Extension in the authors’ working paper - Simplifications and extensions: - Disregard public investment. - Directly postulate the normative goal of minimizing the excess burden of taxation. - Incorporate empirical fact that financial crises, natural disasters, and wars are repeated events with sizable implications for public finances. - Account for asymmetry in risks to public finances: large, positive disturbances to the public debt ratio are much more likely than negative shocks of similar magnitude (IMF, 2016). - Key intuition: sudden surges in debt ratios (wars, bank bailouts) are more common than sudden drops (privatizations, licenses). ### Empirical documentation of asymmetry (U.S. and U.K., long-run) - Data examined: historical time series for the United States and the United Kingdom covering the long term (charts referenced for U.S.: Chart 2; for U.K.: Chart 3). - Observed pattern (1790 to 2014): - Long periods of persistent, gradual declines punctuated by occasional sharp increases in the debt ratio. - Histograms of changes in the debt ratio suggest the distribution is skewed to the right. - The paper confirms rejection of symmetry via a battery of statistical tests. ### Frequency and scale of debt surges (empirical averages) - United Kingdom: - On average, a (positive) outlier year every 28 years. - Average increase in the debt ratio during outlier year: 30.8 percentage points of GDP. - Average decline in the debt-to-GDP ratio in normal years: 1.3 percentage points of GDP. - Corresponding model normative benchmark: 1.1 percentage points. - United States: - On average, a (positive) outlier year every 32 years. - Average increase in the debt ratio during outlier year: 15.4 percentage points of GDP. - Average decline in the debt-to-GDP ratio in normal years: 0.3 percentage points of GDP. - Corresponding model normative benchmark: 0.5 percentage points. ### Key findings and policy implications - Asymmetric risk of large debt-increasing shocks implies a rationale for reducing debt in normal times as insurance against future surges. - Optimal tax smoothing requires small but enduring public debt reductions in normal years. - Empirical behavior of public debt in the U.S. and U.K. over the last 200 years is close to the normative implications of the model. *Source: "An Argument for Paying Down Public Debt", Vitor Gaspar and Julio Escolano, August 26, 2016.* --- ## Content in this bundle - **Analyzing and Managing Fiscal Risks Best Practices; IMF Policy Paper; May 4, 2016** - [Analyzing and Managing Fiscal Risks Best Practices; IMF Policy Paper; May 4, 2016 (Markdown version)](/external/np/pp/eng/2016/050416.pdf.md){rel="alternate" type="text/markdown"} - [Analyzing and Managing Fiscal Risks Best Practices; IMF Policy Paper; May 4, 2016 (PDF)](/external/np/pp/eng/2016/050416.pdf){rel="external" type="application/pdf"} - **Staff Discussion Note** - [Staff Discussion Note (Markdown version)](/external/pubs/ft/sdn/2015/sdn1510.pdf.md){rel="alternate" type="text/markdown"} - [Staff Discussion Note (PDF)](/external/pubs/ft/sdn/2015/sdn1510.pdf){rel="external" type="application/pdf"} --- ## References - [recent working paper](https://www.imf.org/external/pubs/cat/longres.aspx?sk=44200.0) _Source: https://www.imf.org/en/blogs/articles/2016/08/26/an-argument-for-paying-down-public-debt_