From the bank of banks, the Bank of International Settlements - long, but worth the read. Here is the conclusion:
5. Conclusion
Our examination of the future of public debt leads us to several important conclusions. First,
fiscal problems confronting industrial economies are bigger than suggested by official debt
figures that show the implications of the financial crisis and recession for fiscal balances. As
frightening as it is to consider public debt increasing to more than 100% of GDP, an even
greater danger arises from a rapidly ageing population. The related unfunded liabilities are
large and growing, and should be a central part of today’s long-term fiscal planning.
It is essential that governments not be lulled into complacency by the ease with which they
have financed their deficits thus far. In the aftermath of the financial crisis, the path of future
output is likely to be permanently below where we thought it would be just several years ago.
As a result, government revenues will be lower and expenditures higher, making
consolidation even more difficult. But, unless action is taken to place fiscal policy on a
sustainable footing, these costs could easily rise sharply and suddenly.
Second, large public debts have significant financial and real consequences. The recent
sharp rise in risk premia on long-term bonds issued by several industrial countries suggests
that markets no longer consider sovereign debt low-risk. The limited evidence we have
suggests default risk premia move up with debt levels and down with the revenue share of
GDP as well as the availability of private saving. Countries with a relatively weak fiscal
system and a high degree of dependence on foreign investors to finance their deficits
generally face larger spreads on their debts. This market differentiation is a positive feature
of the financial system, but it could force governments with weak fiscal systems to return to
fiscal rectitude sooner than they might like or hope.
Third, we note the risk that persistently high levels of public debt will drive down capital
accumulation, productivity growth and long-term potential growth. Although we do not
provide direct evidence of this, a recent study suggests that there may be non-linear effects
of public debt on growth, with adverse output effects tending to rise as the debt/GDP ratio
approaches the 100% limit (Reinhart and Rogoff (2009b)).
5. Conclusion
Our examination of the future of public debt leads us to several important conclusions. First,
fiscal problems confronting industrial economies are bigger than suggested by official debt
figures that show the implications of the financial crisis and recession for fiscal balances. As
frightening as it is to consider public debt increasing to more than 100% of GDP, an even
greater danger arises from a rapidly ageing population. The related unfunded liabilities are
large and growing, and should be a central part of today’s long-term fiscal planning.
It is essential that governments not be lulled into complacency by the ease with which they
have financed their deficits thus far. In the aftermath of the financial crisis, the path of future
output is likely to be permanently below where we thought it would be just several years ago.
As a result, government revenues will be lower and expenditures higher, making
consolidation even more difficult. But, unless action is taken to place fiscal policy on a
sustainable footing, these costs could easily rise sharply and suddenly.
Second, large public debts have significant financial and real consequences. The recent
sharp rise in risk premia on long-term bonds issued by several industrial countries suggests
that markets no longer consider sovereign debt low-risk. The limited evidence we have
suggests default risk premia move up with debt levels and down with the revenue share of
GDP as well as the availability of private saving. Countries with a relatively weak fiscal
system and a high degree of dependence on foreign investors to finance their deficits
generally face larger spreads on their debts. This market differentiation is a positive feature
of the financial system, but it could force governments with weak fiscal systems to return to
fiscal rectitude sooner than they might like or hope.
Third, we note the risk that persistently high levels of public debt will drive down capital
accumulation, productivity growth and long-term potential growth. Although we do not
provide direct evidence of this, a recent study suggests that there may be non-linear effects
of public debt on growth, with adverse output effects tending to rise as the debt/GDP ratio
approaches the 100% limit (Reinhart and Rogoff (2009b)).
Finally, looming long-term fiscal imbalances pose significant risk to the prospects for future
monetary stability. We describe two channels through which unstable debt dynamics could
lead to higher inflation: direct debt monetisation, and the temptation to reduce the real value
of government debt through higher inflation. Given the current institutional setting of
monetary policy, both risks are clearly limited, at least for now.
How to tackle these fiscal dangers without seriously jeopardising the incipient recovery is the
key challenge facing policymakers today. Although we do not offer advice on how to go
about this, we believe that any fiscal consolidation plan should include credible measures to
reduce future unfunded liabilities. Announcements of changes in these programmes would
allow authorities to wait until the recovery from the crisis is assured before reducing
discretionary spending and improving the short-term fiscal position. An important aspect of
measures to tackle future liabilities is that any potential adverse impact on today’s saving
behaviour be minimised. From this point of view, a decision to raise the retirement age
appears a better measure than a future cut in benefits or an increase in taxes. Indeed, it may
even lead to an increase in consumption (see eg Barrell et al (2009) for an analysis applied
to the United Kingdom).
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