Posted onDealing with high public debt is never easy, but for many advanced economies the current
environment poses new challenges.2 Sovereign debt is approaching historical highs, largely
reflecting the work of automatic stabilizers, counter-cyclical fiscal policy, and financial sector
bail-outs. However, a weak medium-term growth outlook complicates the task of putting debt
back on a clearly declining path. This shifts the burden of adjustment on fiscal policy at a time
when fiscal accounts are already under pressure from underlying structural changes, such as
continued population aging and rising health-care spending.
In the past, output growth and fiscal adjustment were the main drivers behind debt reversals.
An analysis of 26 episodes of large debt reversals in advanced economies since the 1980s and
other empirical evidence suggest that periods of decreasing debt were often associated with
higher growth rates and strong primary balances. Inflation, interest rates, and stock-flow
adjustments also affected debt dynamics, although they played relatively minor roles.
Historically, debt reductions have tended to be smaller and less frequent in more challenging
macroeconomic environments of moderate growth and higher interest rates; when debt
reductions have succeeded under such conditions, it was mostly due to a strong fiscal effort.
Front-loaded consolidations, in particular, have tended to increase public debt in the short run,
even as risk premiums fell. Empirically, fiscal effort has been more likely to reduce public debt
when growth has been stronger. Illustrative calculations show how the debt-to-GDP ratio
increases in the short run when fiscal consolidations come at the cost of lower economic
activity. Front-loaded consolidation can lead to greater output loss than a gradual effort does,
even though it can also reduce the overall magnitude of the adjustment needed. In addition,
while credibility effects can ease the pain of fiscal adjustment through lower risk premiums,
this is unlikely to fully offset the short-run adverse impact on economic activity.
Some of the most successful historical public debt reversals also started under adverse
circumstances—such as high debt, high interest rates, and low initial rates of growth—and
provide encouraging examples for the task ahead:
3 The typical growth-interest rate differential
was close to zero. Ultimately, supportive external demand and monetary policy helped
economic growth and offset the contractionary impact of initial large fiscal adjustments.
Typically, reductions in debt-to-GDP ratios have coincided with pick-ups in growth. Fiscal
efforts continued as growth improved, leading to high primary surpluses.more
environment poses new challenges.2 Sovereign debt is approaching historical highs, largely
reflecting the work of automatic stabilizers, counter-cyclical fiscal policy, and financial sector
bail-outs. However, a weak medium-term growth outlook complicates the task of putting debt
back on a clearly declining path. This shifts the burden of adjustment on fiscal policy at a time
when fiscal accounts are already under pressure from underlying structural changes, such as
continued population aging and rising health-care spending.
In the past, output growth and fiscal adjustment were the main drivers behind debt reversals.
An analysis of 26 episodes of large debt reversals in advanced economies since the 1980s and
other empirical evidence suggest that periods of decreasing debt were often associated with
higher growth rates and strong primary balances. Inflation, interest rates, and stock-flow
adjustments also affected debt dynamics, although they played relatively minor roles.
Historically, debt reductions have tended to be smaller and less frequent in more challenging
macroeconomic environments of moderate growth and higher interest rates; when debt
reductions have succeeded under such conditions, it was mostly due to a strong fiscal effort.
Front-loaded consolidations, in particular, have tended to increase public debt in the short run,
even as risk premiums fell. Empirically, fiscal effort has been more likely to reduce public debt
when growth has been stronger. Illustrative calculations show how the debt-to-GDP ratio
increases in the short run when fiscal consolidations come at the cost of lower economic
activity. Front-loaded consolidation can lead to greater output loss than a gradual effort does,
even though it can also reduce the overall magnitude of the adjustment needed. In addition,
while credibility effects can ease the pain of fiscal adjustment through lower risk premiums,
this is unlikely to fully offset the short-run adverse impact on economic activity.
Some of the most successful historical public debt reversals also started under adverse
circumstances—such as high debt, high interest rates, and low initial rates of growth—and
provide encouraging examples for the task ahead:
3 The typical growth-interest rate differential
was close to zero. Ultimately, supportive external demand and monetary policy helped
economic growth and offset the contractionary impact of initial large fiscal adjustments.
Typically, reductions in debt-to-GDP ratios have coincided with pick-ups in growth. Fiscal
efforts continued as growth improved, leading to high primary surpluses.more
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