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The Future of Public Debt: Prospects and Implications

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

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The Future of Public Debt: Prospects and Implications

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  1. 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. 1

  2. 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

  3. 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.

  4. Outline • Current facts • The trajectory • Challenges for policymakers

  5. 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

  6. 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

  7. 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

  8. 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

  9. Debt and monetary policy • Inflation expectations • Forecast uncertainty

  10. 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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