Debt targets can serve as a fiscal policy anchor to ensure the sustainability of fiscal policy and that there is sufficient policy room to cope with adverse shocks. Prudent debt targets provide the commitment tool that re-assures markets and thereby diminishes risk premia and the cost of active fiscal policy.
Achieving prudent debt targets using fiscal rules, Policy brief
Prudent debt targets and fiscal frameworks, Long paper
Fig 1: Public debt ranges under a prudent scenario
Panel B. Average annual primary balance between
Note: The thick horizontal lines show the median debt level, boxes show the interquartile range, and extreme values are the 5th and the 95th percentiles. Only those countries that need to generate a primary surplus are shown.
Figure 2: Debt limits
Government financial liabilities, % of GDP
Source: Fall, F. and J-M. Fournier (2015), Macroeconomic Uncertainties, Prudent Debt Targets and Fiscal Rules
An assessment of the effect of debt on economic activity suggests that beyond a debt threshold, government debt can undermine economic activity and the ability to stabilise the economy:
Prudent debt targets should be set to avoid an overshooting of the debt thresholds in the case of adverse shocks. Prudent debt targets take into account uncertainties surrounding macroeconomic variables and are thus country-specific. Prudent debt targets are on average 15 percentage points lower than debt thresholds (Figure 1).
Note to figure 2: The long-term recession risk is the probability of GDP per capita growth to become negative. The uncertainty surrounding the debt trajectory is assessed by the interquartile range of the debt level in 2040. The “Constant primary balance” simulation is a stylised scenario in which the actual primary balance is kept constant such that the prudent debt target is reached, with no automatic stabilisers. In the scenario labelled “Automatic stabilisers”, a one percentage point negative surprise in the output gap is associated with a 0.4% of GDP stimulus.
The main papers providing background to this note are:
Fall, F., D. Bloch, J.-M. Fournier and P. Hoeller (2015), Prudent Debt Targets and Fiscal Frameworks
Bloch, D. and F. Fall (2015), Government Debt Indicators: Understanding the Data
Fall, F. and J-M. Fournier (2015), Macroeconomic Uncertainties, Prudent Debt Targets and Fiscal Rules
Fournier, J-M. and F. Fall (2015), Limits to Government Debt Sustainability