Fiscal Policy In An Era Of High Debt – Speech

Introductory Remarks for the Conference “Fiscal Policy in an Era of High Debt”

Since the mid-1970s, global public debt has tripled to reach 92 percent of GDP by the end of 2022. 

So, debt levels had been rising for some time. 

On top of that, more costs lie ahead: from large spending needs from ageing populations in advanced economies, to achieving sustainable development goals in emerging and developing economies. 

What does this mean for our member countries? Rising deficits and debts in countries such as the United States have serious ramifications for emerging and developing economies, who are hit by rising rates and weaker currencies. And many economies, particularly low-income countries, are already in debt distress. 

The combination of record-high global debt levels, higher for longer interest rates, and weak growth prospects poses a triple challenge for policymakers. In a shock-prone world, very few countries will have the fiscal space to support their economies. 

To help our 190 member countries navigate these challenges, we need a renewed focus on fiscal policy to make sure it is fit for purpose. 

That will require more research, improved models, and better empirical evidence to guide us. I am therefore very encouraged that many of the papers that will be presented at this conference go in this direction.

As we discuss this important and timely research over the next two days, let me highlight four priorities.

First, consider how to pay for it all. Demands on government budgets are increasing—from delivering social support (insurer of first resort), to financing the green transition, to bolstering defense spending, to a renewed push for industrial policies and sectoral subsidies. 

In today’s environment—where it is politically difficult to cut spending or raise taxes—debt-financed spending may still seem tempting. But that would be a grave mistake, setting debt on an unsustainable trajectory as borrowing costs rise sharply. 

Governments need to rethink what they can and cannot do. They cannot be the insurer of first resort for all shocks. Revenues also need to keep up with spending. For our part, the IMF must balance our cautionary policy advice with an understanding of the economic and social forces underpinning these political choices.

Second, understand monetary and fiscal interactions. Over the past two years, central banks around the world have grappled with how to address elevated and persistent inflation levels. In several cases fiscal policy has not been in sync with monetary policy and that has complicated the fight against inflation. Much more needs to be understood about the precise mechanisms through which fiscal-monetary interactions unfold. 

For example, we have seen large movements in term premia in long-term government bond yields. What are the implications for monetary policy. Looking ahead, what are the implications for the natural rate, r*, of the projected increase in government debt? Policymakers in emerging markets and developing economies, have long had to grapple with large swings in financing conditions that were not directly linked to domestic monetary policy actions. Would we expect to see more of that in advanced economies? 

Third, evaluate vulnerabilities arising not only from public debt levels but also from the composition of debt—the identity of creditors, currency and maturity composition that apply. 

This is relevant for both advanced and emerging market economies. In the United States, for example, a third of government debt is set to mature in the coming year. The Treasury must decide on the appropriate interest rate maturity to lock-in with its issuances, against the backdrop of an uncertain path for future policy rates and term premia. 

In emerging markets, decisions on debt composition becomes even more intricate, as they determine exposure to fluctuations in global risk sentiment in an increasingly shock-prone world. The composition of the investor base is also changing. For instance, countries like Brazil and Mexico have experienced a large influx of foreign investors into their local currency denominated bonds.

The change in the creditor landscape, with a growing number of non-Paris club creditors like China, India, and Saudi Arabia, has implications for the processes involved in debt restructuring. While important progress has been made, a lot more is needed for countries to receive timely debt relief. 

Fourth, help countries get on a sustainable fiscal path. For most countries, reducing debt ratios involves curtailing budget deficits. Over 100 countries have fiscal rules, but deviations are frequent, and few have contained debt since the Global Financial Crisis. We need rules that respond to shocks but with clear mechanisms to correct for non-compliance and that are anchored on spending targets. Independent fiscal councils can also enhance checks and balances.

On that note, let me conclude. 

These are challenging and complex times for policymakers, with more challenges—and policy questions—on the horizon. The insights and research presented at this conference can help us shape the trajectory of fiscal policy so that governments can continue to deliver for their people.