When is repaying public debt not of the essence?

By Blog Admin, on 19 June 2015

Raphael Espinoza

Raphael Espinoza (UCL, Centre for Comparative Studies of Emerging Economies, SSEES) reports on the latest research being carried out at SSEES into debt repayment strategies.

My co-authors at the IMF, Jonathan D. Ostry and Atish R. Ghosh, have written a blog post “When When i Repaying Public Debt Not Of the Essence”, summarizing our joint work that is contributing to the debate on debt repayment strategies in countries with fiscal space such as the UK or the US.

See for instance, in the Guardian, the Telegraph, the Wall Street Journal, the Financial Times, The Economist , as well as comments by Simon Wren-Lewis, Martin Sandu, David Wessel, and Maya MacGuineas.

The original blog post is summarized below

Recent debates have centered on the pace at which to pay down this debt, with few questions being asked about whether the debt needs to be paid down in the first place.

A radical solution for high debt is to do nothing at all—just live with it. Indeed, from a welfare economics perspective—abstracting from real world problems such as rollover risk—this would be optimal. […] While there are some countries where clearly debt needs to be brought down, there are others that are in a more comfortable position to fund themselves at exceptionally low interest rates, and that could indeed simply live with their debt. […]
The case for living with debt

A simple way to understand the basic intuition for just living with debt is to recall Robert Barro’s “tax-smoothing” principle (whereby constant tax rates are efficient because distortionary costs are typically convex—rising at a faster rate—in the tax rate). The economic burden of public debt is the distortionary cost associated with the taxes needed to service it, potentially in perpetuity. But that is a sunk cost, already incurred, and— short of default—now unavoidable. It provides no reason to further distort the economy by temporarily raising taxes only to lower them again once the debt has been paid down.


The benefit from repayment is small for countries with ample fiscal space because, while sovereign debt crises are costly when they occur, their occurrence is rare, even at elevated debt levels, and more importantly the probability curve is very flat in the debt level, so that crisis risk hardly falls when debt is reduced from, say, 120 to 100 percent of GDP. The cost of reducing debt can be much larger, however, even if adjustment is spread out over several years (the cost rises steeply if the pace of adjustment is faster), because distortive taxes or cuts in productive spending (needed to run a budgetary surplus) have a deleterious permanent effect on the capital stock, output, and consumption.

No mechanical exercise

Advanced economies are contending with some of the highest debt ratios seen since the Second World War. But not all are in the same boat: for some, whose sustainability is more precarious, reducing debt is the imperative. Others are in a more ambiguous situation where there is no immediate risk of funding problems but nor is there any room for complacency. And a few appear to be in the “green zone” with ample fiscal space. Of course, deciding which zone a country is in is not a mechanical exercise but will require judgments based on stress testing fiscal balance sheets to withstand extreme shocks. But the mantra that it is always desirable to reduce public debt must not go unquestioned. A comparison of costs and benefits must underpin policy advice. For countries in the green zone, the case for living with the debt is a strong one.

Note: This article gives the views of the author(s), and not the position of the SSEES Research blog, nor of the School of Slavonic and East European Studies, nor of UCL.