A Future with High Public Debt: Low-for-Long Is Not Low Forever

Many countries are experiencing a combination of high public debt and low interest rates. This was already the case in advanced economies even prior to the pandemic but has become even starker in its aftermath. A growing number of emerging market and developing economies are likewise enjoying a period of negative real rates—the interest rate minus inflation—on government debt. The IMF has called on countries to spend as much as they can to protect the vulnerable and limit long-lasting damage to economies, stressing the need for spending to be well targeted. This is especially critical in emerging market and developing economies, which face tighter constraints and associated fiscal risks, where greater prioritization of spending is of the essence.

But what should eventually be done about the high levels of public debt in the aftermath of this crisis? In an earlier paper we showed that, provided fiscal space remains ample, countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically. More recently, the IMF has stressed the need to rethink fiscal anchors—rules and frameworks—to take account of historically low interest rates. Some have suggested that borrowing costs—even if they move up—will do so only gradually, leaving time to contend with any fallout.

Two issues seem salient. First, will borrowing remain cheap for the entire horizon relevant for fiscal planning? Since that horizon seems to be the indefinite future, our answer here would be “no.” While some have argued that permanently negative growth-adjusted interest rates might be a reasonable baseline, we would highlight the risks around such a benign future. History gives numerous episodes of abrupt upticks in borrowing costs once market expectations shift. This risk is especially relevant for emerging market and developing economies where debt ratios are already high. At some point, debts may well need to be rolled over at higher rates. Limits to how much can be borrowed have not disappeared, and the need to stay well clear of them is even sharper in a world where interest rates and growth are uncertain.

Second, will it suffice to respond gradually to higher interest rates? Our answer again is “no.” Theory and history suggest that, when investors begin to worry that fiscal space may run out, they penalize countries quickly. Market-driven adjustments are not necessarily gradual, nor do markets only ratchet up the cost of borrowing once healthy growth returns—indeed, just the opposite seems plausible.

There are deeply engrained market expectations of negative interest-growth differentials (where real interest rates are less than growth rates) for most advanced economies. While long-term rates in the United States have been rising for the past several months, they remain low even by post-2008 standards. The chart below compares the Consensus Forecast for growth in the G7 economies with the real interest rate (10-year bond yield minus inflation) in 2030. The forecasts imply growth rates well in excess of real interest rates for all G7 countries except Italy.

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Πηγή: blogs.imf.org

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