Cost to Growth of Debt Reduction Could Be Significant: IM

Debt reduction by governments across the globe will require a “sustained commitment” to fiscal consolidation that could increase their debt ratios in the short term, the International Monetary Fund said.

The cost to economic expansion could be significant in the short term, indicating the importance of getting the pace of fiscal consolidation right and acting to mitigate the negative effect on growth, according to an IMF report released today in Brussels.

“The good news is that high debt can be tamed even when growth is low,” said Helge Berger, an adviser in the IMF’s European department, and Justin Tyson, a senior economist in the department. “The bad news is that fiscal consolidation will likely come with an initial price of lowering growth,” they said in a blog post based on today’s report.

“This means that, where possible, consolidation should happen gradually, supported by credible medium-term plans that help to spread the effort over time,” Berger and Tyson said. “Any measures to increase medium-term growth, such as structural reforms, should also be enacted now.”

Advanced economies are under pressure to reduce debt levels that are approaching all-time highs at a time of low economic growth, making the task more difficult. According to the IMF’s World Economic Outlook, average output growth in the largest economies between 2013 and 2018 could be almost 1.5 percentage points below the rates experienced by them between 1980-2007.

Debt Ratio

At the same time, the U.S. had a debt ratio of 106.5 percent of GDP in 2012, according to IMF data. Japan’s debt amounted to 237.9 percent of its economic output and Italy’s was 127 percent.

The combination of slow economic expansion and high borrowing costs makes debt reversal “particularly challenging” for some high-debt countries, especially in the euro area. “When interest rates are high, financing debt becomes more expensive, complicating efforts to reduce debt,” the authors of the report said.

With monetary policy around the world “operating at or close to the lower bound,” little to be gained from higher rates of inflation and questions about the extent to which privatizations can be successful, “the burden of lowering debt levels will fall more squarely on fiscal consolidation,” according to the report.

In addition, “the looming surge of age-related spending will complicate the task” of reducing debt levels, according to the report. “Age-related health-care spending in advanced economies is estimated to increase by more than three percentage points of gross domestic product over the next 20 years.”

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