HOW MUCH PUBLIC DEBT IS TOO MUCH? / THE ECONOMIST

The limits of borrowing

How much public debt is too much?

Interest rates and growth define the threshold for danger

Illustration: Ben Wiseman

ONE REASON economists have a poor record of predicting fiscal crises is that there is no defined level at which debt can be said to be too high. 

They prefer to assess whether a debt-to-GDP ratio is stable or increasing.

The trouble is that a ratio that is stable one moment can be explosive the next. 

Consider an extreme hypothetical: debt-to-GDP of 1,000%. 

In theory, even this can be stable: with 2% growth, 2% inflation and a roughly 4% interest rate, the country could borrow the 40% of GDP it needed to pay its annual interest bills without increasing the debt-to-GDP ratio.  

It would just need to balance its “primary” budget, which excludes interest payments.

Yet a rise of just one percentage point in the interest rate or an equivalent fall in the growth rate would mean needing a primary surplus of 10% of GDP to stop the ratio exploding. 

Such surpluses never happen. 

Default or inflation would arise instead.

How much risk will markets bear? 

Like banks, highly indebted governments are vulnerable to runs. 

Fear of a crisis can start a crisis, by pushing up financing costs. 

It is also a matter of politics: how much will governments tighten their belts? 

High debts also slow growth and push up rates, by sucking up capital that could be spent productively. 

Models that account for this feedback loop show high-debt countries to be still more vulnerable to a crisis.

We have produced simulations showing the sensitivity of the debt-to-GDP ratio of five major economies. 

We take the IMF’s latest forecast, then project a bad scenario in which the interest rate-growth differential is 0.5 percentage points higher than assumed and primary deficits 0.5 points wider. 

We also produce a good scenario with mirror-image assumptions. 

America and France see rising debts in all cases because their forecast primary deficits are so large. 

Italy and Japan—the most indebted major economies—face highly variable trajectories. 

Their high debts leave them more at the mercy of economic conditions.