ACHIEVING PRUDENT DEBT TARGETS AND FISCAL RULES

Catherine L. Mann

OECD Chief Economist

Aix-en-Provence3 July 2015

http://www.oecd.org/eco/achieving-prudent-debt-targets-using-fiscal-rules.htm

• OECD average gross government debt increased by 36 percentage points from 2007 to 2013 to reach 110% of GDP.

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Rising government debt raises concerns

0

50

100

150

200

Per cent GDP

2007 2013

Source: OECD (2014), "OECD Economic Outlook No. 96", OECD Economic Outlook: Statistics and Projections (database).

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• Three questions: – How should a government debt target

be set?– What should be the prudent debt-to-

GDP ratio countries should target over the medium term?

– How can fiscal frameworks be designed to achieve prudent debt targets while providing scope to respond to the economic cycle?

Designing debt targets and fiscal frameworks

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Limits to debt sustainability

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• Debt limits cannot be the anchor of prudent debt targets

Sustainability limits may look high, but countries should steer clear of them

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50

100

150

200

250

300

350

% GDP Gross debt in 2013 Debt limit (model based interest rate) Debt limit (current interest rate)

Source: Fournier and Fall (2015)

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• The debt threshold takes into account: • the impact of debt on growth,• the effectiveness of fiscal policy, • and the link between debt and the provision of

public infrastructure.

– It seems that gross debt above about 80% of GDP has detrimental consequences.

• More precisely:• Advanced economies debt threshold: 70-90% of GDP• Euro area countries debt threshold: 50-70% of GDP• Emerging economies debt threshold: 30-50% of GDP

Defining a debt threshold as the anchor of prudent debt targets

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• A stochastic debt analysis was performed.

• The cushion that is needed to stay below debt thresholds in the case of adverse shocks was calculated.

• The prudent debt target is the median debt by 2040 such that there is less than a 25% risk to go beyond the debt threshold.

Designing prudent debt targets

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Country by country prudent debt targetsPrudent debt levels

Average annual fiscal effort (primary balance surplus) by 2040

0

25

50

75

100

125

150G

RC

IRL

SV

K

FIN

PR

T

SV

N

NL

D

ES

P

DE

U

BE

L

FR

A

ITA

AU

T

JPN

CA

N

ISR

PO

L

US

A

GB

R

Per cent of GDP

0

1

2

3

4

5

6

7

GR

C

IRL

SV

K

FIN

PR

T

SV

N

NL

D

ES

P

DE

U

BE

L

FR

A

ITA

AU

T

JPN

CA

N

ISR

PO

L

US

A

GB

R

Per cent of GDP

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• The role of the prudent debt target: effective in anchoring expectations about future fiscal policy. The prudent debt target serves as the reference point to define numerical fiscal rules.

• Fiscal rules:– Role: Promote fiscal discipline and long-term growth

(well-being).

– Objectives: (1) Anchor fiscal policy expectations by targeting a prudent debt level and (2) allow for macroeconomic stabilisation.

– Challenge: The trade-off between reducing recession risks and debt trajectory uncertainty.

Designing effective fiscal frameworks

Budget balance Structural balance Expenditure rule Revenue rule Fiscal stabilisation - + + - Fiscal discipline ++ + + -+ Side-effects and risks - -- - -

Benchmarking existing rules

• The adoption of a budget balance rule complemented by an expenditure rule is promising. • A budget balance rule ensures hitting the debt

target. • And, well-designed expenditure rules ensure

the effectiveness of a budget balance by limiting pro-cyclicality and too dynamic spending.

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Panel A. GDP growth (%)

Panel B. Primary balance (% of GDP)

Panel C. Public debt (%)

Comparing past behaviour and budget balance rule + spending rule: the example of France

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5

10

15

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25

30

35

Group 1 Group 2 Group 3 Group 4 Group 5 Group 6

Per centConstant primary balance Automatic stabilisers Additional stimulus

Spending rule Include interest payments Debt rule

0

5

10

15

20

25

30

35

40

45

Group 1 Group 2 Group 3 Group 4 Group 5 Group 6

Per cent GDP

Panel B. Debt level uncertainties

Panel A. Long-term recession risks

AUS, ISR, KOR, NZL, POL, CHE , USA

CAN, CZE , SVK

DNK, LUX, SWE, GBR

AUT, BEL, FIN, FRA,

DEU, NLD, SVN

GRC, IRL, ITA,

PRT, ESPJPN

The trade-off between counter-cyclicality and hitting the debt target

Strict primary balance rule: target is constant

Rule allowing automatic stabilisers to operate

FRA

GBR

DEU

USAJPN

ESP

0

5

10

15

20

25

30

35

40

0 10 20 30 40 50

Debt ratio uncertainties (% of GDP)

Long-term recession risks (%)

0

5

10

15

20

25

30

35

40

0 10 20 30 40 50

• Debt thresholds for groups of countries:• For higher-income countries, a debt threshold range of 70 to

90% of GDP. • For euro area countries, the debt threshold is lower at 50-70%• Emerging economies have a debt threshold at 30 to 50%

• The average prudent debt target which minimise the probability of hitting the threshold is 15 percentage points lower than the threshold.

• The fiscal framework should have two objectives: ensuring fiscal discipline and permitting stabilisation policies.

• A combination of a budget balance rule and an expenditure rule suits most countries well: • A budget balance rule encourages hitting the debt target. • And, well-designed expenditure rules appear decisive to

ensure the effectiveness of a budget balance rule and can foster long-term growth.

Main messages

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Further information

Disclaimers: The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

Fall, F., D. Bloch, J.-M. Fournier and P. Hoeller (2015), “Prudent Debt Targets and Fiscal Frameworks”, OECD Economic Policy Papers, No. 15, OECD Publishing, Paris.

Bloch, D. and F. Fall (2015), "Government Debt Indicators: Understanding the Data", OECD Economics Department Working Papers, No. 1228, OECD Publishing.

Fournier, J-M. and F. Fall (2015), "Limits to Government Debt Sustainability", OECD Economics Department Working Papers, No. 1229, OECD Publishing. Fall, F. and J-M. Fournier (2015), "Macroeconomic Uncertainties, Prudent Debt Targets and Fiscal Rules", OECD Economics Department Working Papers, No. 1230, OECD Publishing.

THANK YOU

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