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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.

Cecchetti

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

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Cecchetti

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.

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Cecchetti

Outline

   Current facts The trajectory Challenges for policymakers

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Table 1 Fiscal situation and prospects 1

Fiscal balance Structural balance 5 General government debt 6 As a percentage of GDP Austria Germany Greece France Ireland Italy Japan Netherlands Portugal Spain United Kingdom United States China India Other Asia 2 Central Europe 3 Latin America 4 2007 –0.7 0.2 –4.0 –2.7 0.2 –1.5 –2.5 0.2 –2.7 1.9 –2.7 –2.8 0.9 –4.4 2.1 3.7 –1.5 2010 –5.5 –5.3 –9.8 –8.6 –12.2 –5.4 –8.2 –5.9 –7.6 –8.5 –13.3 –10.7 –2.0 –10.0 –1.2 –4.4 –2.4 2011 –5.8 –4.6 –10.0 –8.0 –11.6 –5.1 –9.4 –5.3 –7.8 –7.7 –12.5 –9.4 –2.9 –8.7 –1.0 –3.9 –2.0 2007 –1.4 –0.8 –4.5 –3.5 –1.3 –2.2 –3.4 –0.6 –2.8 1.6 –3.4 –3.1 2010 –3.3 –4.0 –6.9 –6.8 –9.0 –2.6 –7.4 –3.6 –6.1 –5.2 –10.5 –9.2 2011 –3.6 –3.7 –6.8 –6.3 –9.0 –2.8 –9.0 –3.1 –6.8 –4.5 –9.9 –8.2 2007 62 65 104 70 28 112 167 52 71 42 47 62 20 81 31 23 41 2010 78 82 123 92 81 127 197 77 91 68 83 92 22 86 37 28 37 2011 82 85 130 99 93 130 204 82 97 74 94 100 23 86 38 29 35 1 Regional averages calculated as weighted averages based on 2005 GDP and PPP exchange rates. 2 Hong Kong SAR, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand. 3 The Czech Republic, Hungary and Cecchetti 4 Argentina, Brazil, Chile and Mexico. Thailand, central government debt. 5 Cyclically adjusted balance. 6 For Argentina, the Philippines and Sources: IMF,

World Economic Outlook

; OECD,

Economic Outlook

.

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Graph 1 Government gross public debt and primary fiscal balance in industrial economies

1, 2 As a percentage of GDP Shaded areas represent forecast. 1 Weighted average based on 2005 GDP and PPP exchange rates of economies cited and data availability. 2 Australia, Austria, Belgium, Canada, Denmark, France, Finland, Germany, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom and the United States. Sources: OECD; BIS calculations. Cecchetti

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Graph 2 Projected population structure and age-related spending

Old-age population (ratio to working-age population) 1 expenditure from 2011 to 2050 2 1 Working-age population is between 15-64. 2 As a percentage point of GDP. Sources: IMF April 2007 WEO; United Nations Secretariat European Commission; Congressional Budget Office. Cecchetti

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Cecchetti

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

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Graph 2 Projected population structure and age-related spending

Old-age population (ratio to working-age population) 1 expenditure from 2011 to 2050 2 1 Working-age population is between 15-64. 2 As a percentage point of GDP. Sources: IMF April 2007 WEO; United Nations Secretariat European Commission; Congressional Budget Office. Cecchetti

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Debt-to-GDP Projections

Cecchetti      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

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Graph 5 Projected interest payments as a fraction of GDP 1

In per cent Source: Author’s projections. Cecchetti

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Table 3 Required average primary balance to stabilize public debt to GDP ratio at 2007 level

1 over 5 years over 10 years Austria France Germany Greece Ireland Italy Japan Netherlands Portugal Spain United Kingdom United States 4.7 7.3 5.5 5.4 11.8 5.1 10.1 6.7 2.2 6.1 10.6 8.1 2.6 4.3 3.5 2.8 5.4 3.4 6.4 3.7 -0.3 2.9 5.8 4.3 1 As a percentage of GDP. Sources: IMF,

World Economic Outlook

; OECD,

Economic Outlook;

author’s calculations. Cecchetti over 20 years 1.6 2.8 2.4 1.5 2.2 2.5 4.5 2.3 -1.6 1.3 3.5 2.4

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Cecchetti

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

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Graph 6 Sovereign CDS spreads

1

and fiscal indicators

2 General government debt/GDP 3 3 Share of short-term debt 4 5 Cecchetti 1 Vertical axis: average spread over the last 20 working days; in basis points. 2 Horizontal axis. 3 Forecast for 2011. 4 Domestic government debt with a remaining maturity of 1-3 years as per cent of total domestic government debt. 5 Average change in general government debt in per cent of average private savings; forecast average for the period 2009-11. Sources: IMF; OECD; JPMorgan Chase; Markit.

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Cecchetti

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

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Cecchetti

Debt and monetary policy

  Inflation expectations Forecast uncertainty

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Cecchetti

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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