High Public Debt in an Uncertain World: Post-Covid-19 Dangers for Public Finance
In this EconPol Policy Brief Daniel Gros cautions countries with high debt ratios not to simply rely on low interest rates to make their (Covid-19) debt sustainable. Now that the health emergency is subsiding, governments have to chart a new course for public finance. The starting point is a higher level of public debt. However, high debt ratios represent a danger, even when interest rates are low. The key reason is increased uncertainty of growth prospects in a post-Covid-19 economy, coupled with an uncertainty regarding the probability of future large shocks. A prudent policy would therefore be to start reducing debt levels to pre-crisis levels as soon as the economy normalizes, according to the author.
Key messages:
- High debt ratios represent a danger, even if interest rates are low.
- The key reason is increased uncertainty of growth prospects in a post-Covid economy coupled with and uncertainty with regard to the probability of future large shocks.
- Large negative shocks are more frequent than assumed in standard models.
- Another reason is that the cost of public debt might increase more than linearly as the debt ratio rises.
- Large negative shocks create much more problems when debt is already high.
Daniel Gros: "The Dangers of High Public Debt in an Uncertain World", EconPol Policy Brief 38, October 2021