The
Struggle to Manage Debt
March 1, 2018
Good
economic times offer an opportunity to tackle budget deficits
The global economy has a
spring in its step. Growth is picking up, and we at the IMF have been
ratcheting up our forecasts. Government coffers are filling and, with more
people at work, demand for public social support is receding. The fiscal woes
of the past decade seem behind us.
But this sunny perspective
ignores debt levels that remain close to historic highs and the inevitable end
of the cyclical upswing. Estimates of underlying growth potential have hardly
budged, and interest rates—the cost of servicing all this debt—are starting to
rise, which will eventually make it harder to refinance bonds and loans.
How the government taxes,
spends, and manages debt is therefore as hot a political topic as ever. Just
look at recent debates in the US Congress and the German coalition talks. While
fiscal
choices are a matter of politics, recent research and experience can teach
us much about the best path forward. The latest
edition of F&D looks at these issues through various lenses.
Start with the question of
how much debt is too much. Academics and policymakers agree that a general
limit—such as the 60 percent of GDP in the EU Maastricht Treaty—no longer makes
sense; it doesn’t capture enduringly low interest rates and nominal growth or
countries’ complex circumstances or credibility with financial markets. Japan
clearly can carry more debt than, say, Egypt. But few deny the urgency of debt
that is high and rising.
Low-income economies may be
at
greatest risk. Traditionally, they borrowed from official creditors at
below-market rates. But in recent years, many took advantage of rock-bottom
interest rates to load up on commercial debt, leaving them vulnerable to
financial market swings. Higher global rates could divert precious budget
resources to debt servicing from crucial infrastructure projects and social
services. So it is all the more important for these countries to strengthen
their tax capacity.
The recent postcrisis
experience also holds lessons on when to tackle debt—and when not to. Spending
cuts and tax hikes during a recession may only amplify the decline. It is
much less painful to revamp the tax and benefit system when the economy is on
an upswing and as part of a multiyear adjustment. Research shows that the
stimulatory effect of fiscal expansion is weak when the economy is close to
capacity. So increasing budget deficits now would be counterproductive in most
countries. Conversely, taking actions now to raise budget balances toward their
medium-term targets can be achieved at little cost to economic activity.
How best to reduce
deficits? A number of best practices have emerged over the years. To raise
revenue, simplify the tax code, broaden the tax base, and improve collection
capacity. On the spending side, cutting unproductive current expenses (for
instance, on an inefficient civil service) and subsidies (for instance, on
energy consumption) is the way to go. Growth-enhancing infrastructure
investments and crucial social services such as health and education should be
maintained. Well-designed fiscal policy can
address inequality and stimulate growth.
The time to fix the fiscal
roof is now, while the sun is shining. Policymakers should heed the lessons
learned and tackle debt on the upswing.
By IMFBlog|
2018-03-01T11:32:50+00:00 March 1st, 2018|Debt Relief, Economic outlook, Economic research,
Finance, Financial markets,
Fiscal policy, Global Governance,
health, inclusive growth, income, Inequality, infrastructure, interest rates, International
Monetary Fund, Investment,
productivity, Public debt, taxation
