UK need not pay down debt, IMF argues

3 Jun 15

Countries like the UK should not cut public spending to bring down sovereign debt as the impact on the economy could outweigh the benefits, an International Monetary Fund research paper has concluded.

In an analysis considering when governments should attempt to reduce public sector indebtedness, the IMF staff paper, published yesterday, acknowledged that debt represented a deadweight burden on the economy, reducing both investment potential and growth prospects.

However, it concluded that governments which do not face a fiscal crisis “should not pursue policies aimed at paying down the debt”, but instead allow the debt to gross domestic product ratio to decline through growth and “opportunistic” revenues, with the government “living with the debt otherwise”.

The report, authorised for release by IMF chief economist Olivier Blanchard, highlighted that many countries where debt rose following the 2008 financial crisis still retained what it called “fiscal space”, which would allow them to maintain current debt levels without hitting the debt limit for the economy.

Although determining the safe level of debt is difficult, the IMF estimated the United Kingdom retains fiscal space equivalent to 132.6%, based on the current debt-to-GDP ratio and the amount of debt that could be built up before hitting the limit. The latest figures from the Office for National Statistics indicate that UK public sector net debt was nearly £1.5 trillion, amounting to 80.4% of gross domestic product.

Because debt represents a sunk cost, the paper said there was little purpose in the countries with fiscal space paying it down by raising taxes or cutting productive government spending. However, inefficient spending should still be tackled.

“It does not follow that once the debt has been accumulated, it should be paid down to restore growth,” it added.

“On the contrary, where countries retain ample fiscal space, the cure would seem to be worse than the disease – the taxation needed to pay down the debt will be more harmful to growth than living with the debt, and the reduction in sovereign risk that would ensue is likely to be smaller than the distortive cost involved in paying down the debt.

“When fiscal space is limited, incurring this cost is likely to be normatively desirable given the crisis-insurance benefit [of a lower debt burden]. When space is ample – which cannot be established through some mechanical rule but will generally require judgments based on stress testing fiscal balance sheets to withstand extreme shocks – the distortive cost of paying down the debt is likely to exceed the crisis-insurance benefit.”

The examination comes as Chancellor George Osborne prepares for a Budget statement on July 8 to implement Conservative fiscal plans to reach a public spending surplus in 2018/19 to ensure debt falls as a proportion of the economy.

According to the analysis, 21 developed countries are in the safe green zone where they have enough fiscal space to maintain debt levels. These are: United Kingdom, Iceland, Canada, Malta, Austria, Netherlands, United States, Germany, Finland, Sweden, Israel, Singapore, Denmark, Switzerland, Taiwan, Australia, Luxembourg, Hong Kong, New Zealand, South Korea, Norway.

Five nations are in the amber 'warning' zone – Portugal, Ireland, Spain, France, Belgium – while Cyprus, Greece, Italy and Japan have no breathing room.

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