What will it take to stabilise debt in advanced countries?

Debt can be stabilised across advanced economies yet many face sizeable fiscal adjustments and rising vulnerability to market shifts.

This paper analyses the prospects for debt stabilisation in the countries of the European Union, the United Kingdom and the United States, using two methodologies. First, we estimate the level of the structural primary balance that is required to asymptotically stabilise the debt ratio with a 70 percent probability, and assess the plausibility of reaching this level over the medium term, using both historical benchmarks and stochastic forecasts centred on International Monetary Fund projections. Second, we estimate ‘fiscal reaction functions’ that measure the reaction of the primary balance to the debt level.

We find that: 1) debt-stabilising primary balances are generally within historical precedent – well below 3 percent of GDP; 2) the fiscal adjustment required to reach debt-stabilising primary balances is very high in several countries – specifically, the US, France, the UK, Slovakia, Poland and Romania, which must increase their primary fiscal balances by over 5 percentage points of GDP; 3) the feedback coefficient from debt to the primary balance remains positive in all countries, but has significantly declined since the global financial crisis and is not significantly different from zero in most countries.

Our main conclusion is that public debt in the countries in our sample remains sustainable in the sense that the fiscal adjustment required to stabilise the debt is feasible. However, undertaking this adjustment will require a larger and/or more protracted fiscal effort than has been typical for most advanced countries and that is currently expected by the IMF. In the meantime, countries with large adjustment needs could be vulnerable to shifts in market sentiment.

Source : Bruegel