In its October 2012 World Economic Outlook the IMF presented a 135-year study on public debt reduction strategies. It points out that debt stocks of over 100% of GDP have not been uncommon and do not normally lead to restructuring. Indeed, in the developed world out of 26 episodes only 3 ended in default (Germany and Greece). Successful debt-reduction strategies typically use growth-enhancing and easy monetary policies.
IMF World Economic Outlook October 2012
Public debt levels above 100% of GDP are not uncommon. Of the 22 advanced economies for which there is good data coverage, more than half experienced at least one high-debt episode between 1875 and 1997. Furthermore, several countries had multiple episodes: three for Belgium and Italy and two for Canada, France, Greece, the Netherlands, and New Zealand.
The dynamics of the debt-to-GDP ratios [after they reached 100% of GDP] are quite diverse, with some countries experiencing additional large increases and others witnessing sharp reductions.
The episodes are clustered around four major eras: the last quarter of the 19th century, the periods following the two world wars, and the last quarter of the 20th century. The 19th century debt build-up was related mainly to nation building and the railroad boom. The post–World War II episodes are connected with the enormous and widespread military effort and subsequent rebuilding, although some start earlier, during the Great Depression. The episodes in the last cluster during the 1980s and 1990s have their genesis in the breakdown of the Bretton Woods system, when government policy struggled with social issues and the transition to current economic systems.
- The first lesson is that fiscal consolidation efforts need to be complemented by measures that support growth: structural issues need to be addressed and monetary conditions need to be as supportive as possible. In Japan, for example, weaknesses in the banking system and corporate sector limited monetary policy efficacy and led to weak growth, which prevented fiscal consolidation.
- The case of the United Kingdom (from 1918-1933) offers a cautionary lesson for countries attempting internal devaluation. The combination of tight monetary and tight fiscal policy, aimed at significantly reducing the price level and returning to the pre-war parity, had disastrous outcomes. Unemployment was high, growth was low, and— most relevant—debt continued to grow.
- Consolidation plans should emphasize persistent, structural reforms over temporary or short-lived measures. Belgium (from 1983-98) and Canada (1995-2010) were ultimately much more successful than Italy in reducing debt, and a key difference between these cases is the relative weight placed on structural improvements versus temporary efforts. Moreover, both Belgium and Canada put in place fiscal frameworks in the 1990s that preserved the improvement in the fiscal balance and mitigated consolidation fatigue.