D EALING WITH H IGH D EBT IN AN E RA OF L OW G ROWTH S. Ali Abbas, - - PowerPoint PPT Presentation

DEALING WITH HIGH DEBT

IN AN ERA OF LOW GROWTH

• S. Ali Abbas, Bernardin Akitoby,

Jochen Andritzky, Helge Berger, Takuji Komatsuzaki, Justin Tyson International Monetary Fund

SCALE OF THE PROBLEM

Debt at historical highs amid modest growth

Sources: Historical Public Debt Database, IMF Fiscal Monitor, IMF World Economic Outlook, and IMF staff calculations.

• 6
• 4
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2 4 6 8 10 20 30 40 50 60 70 80 90 100 1945 1955 1965 1975 1985 1995 2005

GDP growth (all AE, RHS) GDP growth (Euro Area, RHS) Debt-to-GDP (all AE) Debt-to-GDP (Euro Area)

Gross Debt-to-GDP Ratio and Real GDP Growth (Percent)

A challenging macro-fiscal environment

2013 2014-19 Average Debt ratio Inflation Rate Real Average Interest Rate Real Growth Rate r-g Selected Euro France 93.9 1.4 0.8 1.7

• 0.8

Germany 78.1 1.6 1.2 1.4

• 0.2

Ireland 122.8 1.3 3.0 2.4 0.6 Italy 132.5 1.2 2.8 1.0 1.8 Portugal 128.8 1.3 2.1 1.6 0.5 Spain 93.9 0.9 2.8 1.1 1.7 Non-Euro G7 Canada 89.1 1.9 1.7 2.2

• 0.5

Japan 243.2 2.0

• 0.1

1.0

• 1.1

UK 90.1 2.0 1.9 2.5

• 0.5

US 104.5 1.8 2.1 2.7

• 0.6

Sources: IMF Fiscal Monitor, IMF World Economic Outlook, and Fund staff calaculations.

Main Macroeconomic Indicators for Selected Advanced Economies

(Percent unless otherwise indicated)

WHAT MOVES THE DEBT RATIO?

5 10 15 20 25

• 40 -30 -20 -10

10 20 30 40 50 60 70 Frequency 4-year debt ratio change 5 10 15 20 25

• 40 -30 -20 -10

10 20 30 40 50 60 70 Frequency 4-year debt ratio change

Debt falls with high growth and primary balances…

Above median growth Below median growth High primary balance Low primary balance

Distribution of Debt Ratio Changes (1)

Sources: IMF WEO; and IMF Staff calculations and estimates.

5 10 15 20 25

• 40 -30 -20 -10

10 20 30 40 50 60 70 Frequency 4-year debt ratio change 5 10 15 20 25

• 40 -30 -20 -10

10 20 30 40 50 60 70 Frequency 4-year debt ratio change

…while inflation & interest rates have little impact

Low real interest rate High real interest rate Low inflation High inflation

Density of Debt Ratio Changes (2)

Sources: IMF WEO; and IMF Staff calculations and estimates.

Decomposition of debt changes points to fiscal effort

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ppt

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ppt +3.4 ppt +0.9 ppt

• 2.3

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Structural primary balance Growth Inflation Interest expenditure Stock flow adjustment Total Contribution to Annual Debt Ratio Reductions (Percent of GDP)

Inter- quartile range Mean Sources:IMF World Economic Outlook; and IMF staff calculations.

…but success shaped by economic conditions

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percent of GDP

High Growth

2.4 ppt

• 3.3 ppt

High Real Interest Rate

28%

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0.4 ppt 4.1 ppt

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percent of GDP

Moderate Growth

1.0 ppt

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7%

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• 4.9 ppt

3.2 ppt 8.1 ppt

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Structural primary balance Growth Inflation Stock flow adjustment Interest expenditure Debt ratio change

percent of GDP

Low Real Interest Rate

• 3.4 ppt

3.4 ppt

• 3.4 ppt

34%

• 2.5 ppt
• 1.5 ppt

0.9 ppt 3.4 ppt

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Structural primary balance Growth Inflation Stock flow adjustment Interest expenditure Debt ratio change

percent of GDP

1.7 ppt

• 2.9 ppt

31%

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1.1 ppt 3.1 ppt

CONSOLIDATION AND GROWTH

Complicated interaction and trade-offs

Drivers of debt: fiscal effort, growth, interest rate

Factors Driving Debt Reversals

40 50 60 70 80 90 100 110 120 40 50 60 70 80 90 100 110 120 t-1 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 Debt-to-GDP Baseline w/ fiscal effort w/ fiscal effort and higher g w/ fiscal effort, higher g and lower r Assumptions: Baseline real growth: 1.2 percent (excluding drag from risk premium). Underlying interest rate: 2 percent. Starting debt-to-GDP ratio: 90 percent. Maturity (average): 7 years. Fiscal multiplier: 1 and persists for 4 years. Credibility effect: 15 bps per 1 percent of GDP adjustment. The structural primary balance is adjusted by 2 percent of GDP in t and 1 percent more in t+1. Higher growth and lower interest scenarios increase/decrease baseline rates by 1 percentage point respectively.

Consolidation: to frontload or not to frontload?

Growth and Primary Balance Paths for Achieving a Given Debt Reduction

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• 1.0

0.0 1.0 2.0 3.0 4.0 5.0 6.0 t-1 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 Primary Balances (Percent of GDP) Gradual Up-front

• 9.0
• 7.0
• 5.0
• 3.0
• 1.0

1.0 t-1 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 Deviations from Baseline Output Levels (Percent) Gradual Up-front Up-front (state-dependent multiplier) Assumptions: Baseline real growth: 1.2 percent (excluding drag from risk premium). Underlying interest rate: 2 percent. Starting debt -to-GDP ratio: 90 percent. Maturity (average): 7 years. Fiscal multiplier (regular) : 1 and persists for 4 years. Credibility effect: 15 bps per 1 percent of GDP adjustment. Fiscal multiplier (state-dependent): 1.5, peaks in t+1 and persists for 5 years. The structural primary balance is adjusted in order to meet a 60 percent of GDP target by t+10 under two strategies: gradual adjustment over 5 years (total adjustment needed is 6 percent of GDP) or up-front adjustment (total adjustment needed is 4.8 percent

• f GDP with regular multiplier and 5.3 percent of GDP with state-dependent multiplier).

Credibility effects: Relatively small?

Debt Reversals with Credibility Effects

• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 3.0 4.0 t-1 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 Deviations from Baseline Output (Percent) + fiscal effort + credibility 100 110 120 130 140 150 160 170 t-1 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 Debt (Percent of GDP) Baseline + fiscal effort + credibility Multiplier effect Assumptions: Baseline real growth: 1.2 percent (excl.drag from risk premium). Underlying interest rate: 2 percent. Starting debt-to-GDP ratio: 130 percent (closer to D_max of 170). Maturity (average): 7 years. Fiscal multiplier: 1 and persists for 4 years. Credibility effect: 30 bps per 1 percent of GDP adjustment. Baseline primary balance: -1. The structural primary balance is adjusted by 2 percent of GDP in t and another 1 percent of GDP in t+1.

UNDERSTANDING PAST DEBT REDUCTIONS

26 major debt reductions since 1980

Some starting in quite difficult conditions

Sources: IMF WEO; and IMF Staff calculations.

Did fiscal effort compensate for low growth?

Sustained effort + supportive external demand

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1 2 3 4 5 6 7 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent of GDP Median structural primary balance (25th to 75th percentile region shaded) 2 4 6 8 10 12 14 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median inflation (25th to 75th percentile region shaded)

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2 4 6 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median REER appreciation (25th to 75th percentile region shaded)

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5 10 15 20 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median export value growth (25th to 75th percentile region shaded)

Accommodative monetary policy + credibility effects

1 2 3 4 5 6 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median real GDP growth (25th to 75th percentile region shaded) 1 2 3 4 5 6 7 8 9 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median real long term interest rate (25th to 75th percentile region shaded) 2 4 6 8 10 12 14 16 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median short term treasury bill rate (25th to 75th percentile region shaded) 1 2 3 4 5 6 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 percent Median private consumption growth (25th to 75th percentile region shaded)

POLICY LESSONS

• Examples of successful debt reductions, even

under adverse circumstances

• Current environment shifts much of the burden to

fiscal policy

• Trade-offs (where there is a choice)

Good news and bad news

• Well-designed consolidation: targeted, gradual,

within good medium-term strategy—for those that can wait

• Monetary policy
• Structural reforms for growth

Policies