The advanced economies of the world have taken on additional debt since the global financial crisis. Although the private sector has had some success in de-levering in some of these economies, government debt-to-GDP ratios have generally risen over the past eight years. In these final two installments of special reports on rising financial leverage in advanced economies, we tackle the subject of the sustainability of government debt. We focus on government debt in five non-Eurozone economies in this report. In a companion report, we look at government debt in some countries in the Eurozone.
Analyzing a Range of “Realistic” Scenarios
Economists generally define debt sustainability as a situation in which a country’s debt-to-GDP ratio is stable.
Although a country’s debt-to-GDP ratio is fixed at any point in time, there are essentially an infinite number of paths the ratio could take going forward as growth rates, interest rates and primary balances evolve.
Australia: Government Debt Seems To Be in Fine Shape
Under a “best case” scenario of robust nominal GDP growth, low borrowing costs and small primary deficits, the debt-to-GDP ratio of the Australian government, which currently is about 35 percent, would edge down to roughly 30 percent by 2030.
How Will the Trudeau Government Affect Debt Sustainability?
The general government in Canada is starting at a higher debt-to-GDP ratio—about 90 percent— than its counterpart down under. Moreover, the ratio would rise to nearly 115 percent in 2030 if current observations on nominal GDP growth (0.5 percent), borrowing costs (0.75 percent) and the primary deficit (1.3 percent of GDP) hold for the next 14 years. Under this “current” scenario, the Canadian government would need to take more corrective fiscal action to keep its debt-to-GDP ratio constant.
United Kingdom: More Fiscal Tightening Probably Needed
If, as seems likely, the United Kingdom is not able to achieve strong GDP growth while at the same time enjoying the record low borrowing costs that exist today, then the British government will need to engineer further fiscal consolidation in order to reduce its debt-to-GDP ratio.
The United States Has Its Own Fiscal Challenges
The federal government in the United States has its own set of fiscal challenges over the coming years. Even if nominal GDP growth rebounds to 4.1 percent, average borrowing costs remain at only 1.5 percent and the primary deficit stays at 1.8 percent of GDP (i.e., the “best case” scenario) the debt-to-GDP ratio of the U.S. government would only fall marginally between now and 2030 (Figure 9). Although the primary deficit may edge lower in the next few years, more fiscal adjustment in the United States likely will be needed to bring about a meaningful decline in the government debt-to-GDP ratio. If GDP growth disappoints in coming years, then even more fiscal consolidation will be required to stabilize, let alone reduce, the debt-to-GDP ratio.
Japan: Suspending Disbelief
Among the advanced economies of the world, Japan has the highest debt-to-GDP ratio at nearly 250 percent of GDP. Yet, yields on Japanese government bonds (JGB) out to ten years are negative at present, and the yield on the 30-year JGB is less than 1 percent.
Government debt has generally risen as a percent of GDP over the past eight years in most of the world’s advanced economies. Among the non-Eurozone economies in our study, Japan stands out with an already-high level of government debt that continues to trend higher in most realistic scenarios. Governments in the United Kingdom and the United States likely will need to tighten the fiscal reins at least somewhat, although this may exert downward pressure on rates of economic growth in these economies. Elsewhere, Canadian government debt should remain relatively stable under most realistic scenarios, while Australian government debt also looks to be in fine shape at present.
Read the complete commentary here: advanced-economy-government-debt-20160301