The challenge of managing public debt is a complex issue facing many advanced economies today. With rising debt levels, it is crucial to explore effective strategies for sustainable debt management. In the wake of the global financial crisis and the COVID-19 pandemic, advanced economies have seen their public debt levels soar to unprecedented heights.
As of 2023, general government gross debt exceeded $68 trillion, marking 111% of the gross domestic product (GDP). This staggering figure is not just a number—it’s a harbinger of potential economic stagnation and a signal for urgent action.
The historical context of public debt reveals that advanced economies have previously managed to reduce debt-to-GDP ratios through a combination of high growth, inflation, fiscal surpluses, and financial repression. For instance, the UK’s debt ratio plummeted from 270% in 1946 to a mere 29% by 1990. Similarly, the US saw a significant drop from 121% in 1946 to 36% in 1970. However, the landscape of public debt has drastically changed since then.
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The 1970s marked a turning point, with a shift to primary fiscal deficits and a period of slower growth and inflation. Debt ratios climbed approximately 20 percentage points between 1990 and 2007. The subsequent financial crisis and pandemic further exacerbated the situation, leading to a dramatic increase in debt ratios due to stimulus measures, bailouts, and slower growth.
The implications of such high levels of public debt are manifold. It can lead to increased financial market volatility, structurally slower growth, and higher interest rates. The International Monetary Fund (IMF) has highlighted the risk of “higher for longer” interest rates, which could have international repercussions, potentially dampening global growth and investment.
The phenomenon known as ‘the ratchet effect’—whereby it is politically easier to implement stimulus in bad times than fiscal consolidation in good times—has contributed to the asymmetry in fiscal policy. This has made it challenging for advanced economies to bring down their debt levels during periods of economic recovery.
The evidence suggests that public debt overhang episodes, characterized by debt-to-GDP levels exceeding 90% for at least five years, are associated with lower growth. Among the 26 identified episodes since the early 1800s, 20 lasted more than a decade, indicating that the correlation is not merely a result of debt buildups during business cycle recessions.
Here are some potential solutions that have been identified:
Fiscal Consolidation: This involves implementing a combination of spending cuts and revenue increases. In advanced economies, spending cuts have been more effective in reducing debt ratios than increasing revenues. It is essential that fiscal consolidation is tailored to the country’s specific needs and circumstances.
Growth-Enhancing Reforms: Structural reforms that promote growth can complement fiscal consolidation efforts. These reforms can include measures to improve the business environment, labor market reforms, and investment in innovation and education.
Debt Restructuring: For countries facing debt distress, restructuring the terms of loans may be necessary. This process requires negotiation with creditors and can involve burden sharing among different parties.
Transparency and Collaboration: Improving transparency regarding public debt liabilities can help prevent the build-up of hidden liabilities. Additionally, collaboration among official creditors is crucial for preparing for debt restructuring cases involving non-traditional lenders.
Investment in Sustainable Development: Allocating resources raised from public debt towards investments in sustainable development can yield significant medium- and long-term returns. This approach aligns with the pursuit of the Sustainable Development Goals (SDGs) and can contribute to economic, social, and environmental benefits.
Improving Public Spending Efficiency: Increasing fiscal revenues and enhancing the effectiveness and efficiency of public spending are key to expanding fiscal space. This can involve reviewing and optimizing government expenditures to ensure they contribute to economic growth and development.
Institutional Frameworks: Strong institutional frameworks can support the success of fiscal consolidation and structural reforms. This includes establishing clear rules and mechanisms for fiscal policy and debt management.
The current situation demands a reevaluation of fiscal policies and a concerted effort to address the public debt overhangs. Advanced economies must prioritize discussions on public debt and implement strategies for fiscal consolidation. The long-term health of the global economy may well depend on the actions taken today to manage and mitigate the risks associated with high levels of public debt.