New research examining the impacts of public debt on the finance sector suggests that the true cost of debt may be overstated if interest rates remain low, according to researchers at the International Monetary Fund "Should governments worry about high public debt? The answer from standard debt sustainability frameworks is yes, for not only does real economic growth dip in the immediate aftermath of a fiscal crisis, but the loss of output is often permanent," Marialuz Moreno Badia, lead author on the report notes. The report highlights the lack of empirical literature on the relationship between public debt and fiscal crise, noting it is "still surprisingly inconclusive" to this day. The case for more public debt is being reinforced by weak economic activity across the globe, large investment needs, and increasing concerns that monetary policy may be reaching its limits particularly in advanced economies. And yet, the risk of fiscal crises still casts a long shadow. Therefore, as many countries remain riddled with mounting debt, one of the most pressing questions facing policymakers is whether current high debt levels are a bellwether of future crises with large economic costs
"With public debt soaring across the world, a growing concern is whether current debt levels are a harbinger of fiscal crises, thereby restricting the policy space in a downturn," Badia adds. The analysis finds that public debt is "the most important predictor" of crises, showing strong non-linearities. Moreover, beyond certain debt levels, the likelihood of crises increases sharply regardless of the interest-growth differential. "Our analysis also reveals that the interactions of public debt with inflation and external imbalances can be as important as debt levels. These results, while not necessarily implying causality, show governments should be wary of high public debt even when borrowing costs seem low," Badia concludes.
Read this working paper in full: http://www.imf.org/external/pubs/cat/longres.aspx?sk=48894
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