The Looming Threat of Fiscal Crises
The comments below are an edited and abridged synopsis of an article by Martin Wolf
The IMF has been relaxed about fiscal policy since the financial crisis, but that was the world of lower for longer. Gita Gopinath, first deputy managing director, has called for a renewed focus on fiscal policy.
Public debt has soared. In 2023, the ratio of public debt to GDP of high-income countries is 112%, down from 124% in 2020. The ratio for emerging economies has reached 69% of GDP.
Is a public debt disaster looming? Will there be defaults, inflation, financial repression, or some combination of all three?
Olivier Blanchard, former chief economist of the IMF, commented on the mechanics and risks of debt. On the former, what matters is the relationship between the rate of interest on debt and the rate of growth of the economy and the ratio of the primary fiscal deficit to GDP. On the latter, debt must not grow explosively. The higher the initial ratio and the faster it is likely to grow, the less sustainable the debt is likely to be. Advanced economies can sustain a higher debt ratio if it is not exploding. But interest rates may rise with debt levels. If so, debt dynamics will tend to become explosive.
If debt ratios are to remain stable, the rate of economic growth must equal the average rate of interest when the primary balance is zero. The greater the excess of interest over the growth rate, the larger the primary fiscal surplus must be, and vice versa. Where are the fiscal debts/deficits of high-income economies today?
Wolf discusses the prospects for interest rates and economic growth, noting that they leave an upward shift in equilibrium real rates or tighter monetary policy. If the former, real rates may remain high. If the latter, they should fall when monetary policy normalizes. Real interest rates may be higher than they used to be.
What are the prospective rates of economic growth? The IMF forecasts for 2024-28 real growth averaging 1.9% in the US, 1.8% in Canada, 1.6% in the UK and France, 1.4% in Germany, 0.9% in Italy and 0.6% in Japan. These are decidedly low relative to today’s real interest rates.
If governments are to avoid the risks of a debt explosion and are not going to resort to surprise inflation or financial repression, they will have to tighten what are still ultra-loose fiscal policies. But will they dare do so in aging societies with slow-growing economies? Painful fiscal choices lie ahead.
