When a government has a lot of debt, is it better to implement an austerity plan and pay the debt down? Or, take advantage of low interest rates and invest in the country?
Since the financial crisis, countries around the world have racked up a lot of debt through stimulus programs, financial bailouts, and other monetary and fiscal rescue efforts. When Should Public Debt Be Reduced?, a new paper published by the International Monetary Fund (IMF), reported advanced economies currently have some of the highest debt ratios of the past 40 years.
So, should they be paying off their debts? It all depends on how much ‘fiscal space’ your country has, according to the IMF. The Economist explained it like this:
“This concept [fiscal space] refers to the distance between a government’s debt-to-Gross Domestic Product ratio and an “upper limit”, calculated by Moody’s, a ratings agency, beyond which action would have to be taken to avoid default. Based on this measure, countries can be grouped into categories depending on how far their debt is from their upper threshold… It is a decent measure of how vulnerable a government’s finances are to a shock.”
The IMF report concluded countries already at the upper limit – like Japan, Italy, Greece, and Cyprus – are out of luck. They must take action to reduce debt levels. However, for countries that have fiscal space, there may be merit to the idea of “simply living with (relatively) high debt and allowing debt ratios to decline organically through output growth.”
In other words, if the country’s economy grows faster than its debt, the debt will become a smaller percentage of GDP, resolving the debt issue gradually over time. Given enough time and economic growth, the problem could resolve itself.
The IMF cautioned these conclusions do not constitute policy advice. The paper was intended to fuel debate about the proper course of action for rich, but indebted, countries.
Think About It
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--Dr. Seuss, American writer and cartoonist
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