The Future of Public Debt

The Future of Public Debt: Prospects and Implications Stephen Cecchetti * Economic Adviser and Head Monetary and Economic Department Bank for International Settlements First International Research Conference, Reserve Bank of India 12-13 February 2010 * Views expressed here are those of the author and do not necessarily reflect those of the BIS.

The problem
Public debt is rising sharply in advanced countries
Debt-to-GDP ratios of 100% is becoming common
Should we care?
Post-WWII debts above 100% of GDP were common (examples: US 120%, UK 300%)
Japan has been living with high debt for years
The last industrial countries to default were WWII losers

Things are not as they seem
Consolidation is difficult when
Interest rates are poised to increase
Growth rates are unlikely to rise
Even when consolidation occurs, it stabilises debt to GDP
The long run is much worse
Populations are aging.
Unless policy changes debt will rise to 3+ times its current levels
Problem needs to be addressed now.

Outline
Current facts
The trajectory
Challenges for policymakers

Long-term fiscal imbalances
Age-related spending is exploding
Focus on short-term is incomplete and misleading
Concerns about fiscal sustainability & intergeneration equity: present value of unfunded commitments should be reflected

Debt-to-GDP Projections
30 years and 12 countries
Baseline:
Revenue and non-age related expenditure constant at 2011percentage of GDP
Real interest rate at 1998-2007 average
Potential growth at OECD post-crisis level
Gradual adjustment: Primary deficit improves 1pp of GDP per yr for 5 yrs
Gradual adjustment + freezing age-related spending to GDP at 2011 level
Results Graph 4

Risks and risk premia
Higher debt increases the possibility unstable dynamics
So, higher debt means a bigger risk premium
We plot CDS spreads against
Debt to GDP
Government revenue to GDP
Share of short-term debt
Incremental debt to private saving

Debt and fiscal policy
Higher taxes create greater distortions
Higher debt can mean higher real interest rates
Reduced effectiveness in responding to shocks
All of this can lower the long-run growth path

Debt and monetary policy
Inflation expectations
Forecast uncertainty

Conclusions
Current estimates of public debt ignore the big problem: age-related expenditure
High debts have significant real and financial consequence
Action is needed now.

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The Future of Public Debt

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