MANAGING PUBLIC DEBT AT A TIME OF SLOW GROWTH. Paulo Medas. International Monetary Fund

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1 MANAGING PUBLIC DEBT AT A TIME OF SLOW GROWTH Paulo Medas International Monetary Fund

2 THE SIZE OF THE PROBLEM

3 Debt at historical highs amid modest growth Gross Debt-to-GDP Ratio and Real GDP Growth (Percent) GDP growth (all AE, RHS) GDP growth (Euro Area, RHS) Debt-to-GDP (all AE) Debt-to-GDP (Euro Area) Sources: Historical Public Debt Database, IMF Fiscal Monitor, IMF World Economic Outlook, and IMF staff calculations.

4 Why do we care about high debt? Impact on growth Vulnerability to shocks, market sentiment Ability to use countercyclical policy Risk of disruptive adjustment unable to pay for essential public services Hurt short term growth

5 1.5 The Impact of High Debt on Growth (by sector and indebtedness of other sectors, estimated coefficient) 1 over-indebted sector over-indebted sectors 3 over-indebted sectors Government Corporates Households Sources: Staff estimates.

6 WHAT MOVES THE DEBT RATIO?

7 Decomposition of debt changes points to fiscal effort Contribution to Annual Debt Ratio Reductions (Percent of GDP) ppt Mean -.3 ppt ppt - -. ppt Interquartile range -1.6 ppt +3. ppt -8 Structural primary balance Growth Inflation Interest expenditure Stock flow adjustment Total Sources:IMF World Economic Outlook; and IMF staff calculations.

8 but success shaped by economic conditions High Real Interest Rate percent of GDP ppt 8% -1. ppt High Growth -1. ppt. ppt.1 ppt. ppt percent of GDP ppt 7% -3. ppt Moderate Growth 8.1 ppt -.9 ppt 3. ppt 1. ppt Low Real Interest Rate percent of GDP ppt 3% Structural primary balance -.5 ppt 3. ppt -1.5 ppt.9 ppt Growth Inflation Stock flow Interest adjustment expenditure 3. ppt Debt ratio change percent of GDP ppt 31% Structural primary balance -1.7 ppt 3.1 ppt -1.3 ppt 1.1 ppt Growth Inflation Stock flow Interest adjustment expenditure 1.7 ppt Debt ratio change

9 PAST DEBT REDUCTIONS

10 6 major debt reductions since 198

11 Sustained effort + supportive external demand Median structural primary balance (5th to 75th percentile region shaded) 15 Median export value growth (5th to 75th percentile region shaded) percent of GDP percent t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5 Median inflation (5th to 75th percentile region shaded) -5 6 t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5 Median REER appreciation (5th to 75th percentile region shaded) percent percent - - t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5-6 t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5

12 Accommodative monetary policy + credibility effects 6 5 Median real GDP growth (5th to 75th percentile region shaded) 6 5 Median private consumption growth (5th to 75th percentile region shaded) percent 3 percent t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5 t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5 percent Median short term treasury bill rate (5th to 75th percentile region shaded) percent Median real long term interest rate (5th to 75th percentile region shaded) t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5 t-5 t- t-3 t- t-1 t t+1 t+ t+3 t+ t+5

13 Some lessons from past experience 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) Well designed consolidation: targeted, gradual, within good medium term framework Monetary policy Structural reforms for growth

14 THE CASE OF SPAIN

15 Despite a significant fiscal effort 1 Fiscal Effort = Increase in Primary Structural Balance 8 Fiscal effort 6 Primary deficit (%GDP)

16 The deficit remains high and public debt is rising Public Sector Debt and Deficit, 1 1/ (% GDP) Fiscal balance FIN NDL SVN DEU AUT EA FRA IRL ITA PRT GRC ESP Debt

17 Context: High private leverage Corporate debt - Change between (NFC, percent of GDP) 1 Household Debt - change between 1995 and 7 (percent of disposable income) 8 6 Australia Canada Finland France Germany Italy Netherlands Portugal Spain UK US Sources: OECD - Netherlands Germany France Canada Italy US Finland Portugal Sweden UK Spain Sources: OECD

18 Context: Modest growth Growth Outlook for Euro Area (average GDP yearly growth, percent) Ireland Spain Euro Area France Germany Italy Sources: IMF staff estimates and projections

19 Context: Productivity growth has been low 5 3 Productivity growth has declined sharply over the last decades (Labor productivity=gdp per hour; yearly average %change) 5 TFP 3 3 Labor productivity has been lower and composition worse than international peers, (% change) Labor composition ICT Capital (per hour) Non-ICT capital (per hour) TFP Total 3 1 Labor productivity ITA ESP DNK DEU FRA NLD GBR USA FIN -1 Sources: INE; Eurostat; and IMF staff estimates. Source: OECD.

20 Fiscal Policy Fiscal consolidation needs to continue The structural adjustment path needs to find right balance between supporting the recovery and reducing fiscal deficit/debt over time. Important to ensure a high quality adjustment Should be pro jobs (e.g. reduce taxation on labor; active employment policies) Expenditure review continue to improve spending efficiency Room to increase tax collection (e.g. fight tax evasion; broaden tax bases; focus on indirect taxes)

21 Need continue a gradual consolidation 15 Debt-Creating Flows (in percent of GDP) projection Primary deficit Real GDP growth Real interest rate Exchange rate depreciation Other debt-creating flows Residual

22 Conclusions Spain has done a significant fiscal effort under difficult conditions Fiscal consolidation needs to continue to bring debt dynamics to a more sustainable path The pace and quality of consolidation needs to be growth/job friendly Should be done in conjunction with structural reforms for growth and jobs (productivity; structural unemployment)

23 References (work at IMF) Dealing with High Debt in an Era of Low growth (13) Reassessing the role and modalities of fiscal policy in advanced economies (13) Fiscal Monitor (several issues) The perils of private sector deleveraging in the Eurozone (13)

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