Public Debt: A Survey of Policy Issues

Abstract

The role, the limits and the effects of public debt have long been at the core of the fiscal policy debate. Public debt affects the allocation and distribution of resources and the stabilisation function of government. It reflects decisions taken by previous generations and it constrains those of future generations. History has seen numerous episodes of debt accumulation driven by different economic and political factors. Debt decumulation via consolidation, inflation or default has frequently proved economically problematic and has produced significant political consequences.The debate on public debt has involved economist, philosophers and policy makers, and has highlighted many, sometimes radically different, views. Ricardo refers to the debt as “… one of the most terrible scourges which was ever invented to afflict a nation”, as “… a system which tends to make us less thrifty, to blind us to our real situation”. He feared that the citizen initially “deludes himself with the belief, that he is as rich as before” and then, faced with the taxes levied to pay for the debt, is tempted “… to remove himself and his capital to another country, where he will be exempted from such burthens”. Smith argued that government borrowing would deprive society of resources which could be invested more productively. He also noted that beyond a certain threshold debt inevitably leads to national bankruptcy.However, classical economists were also well aware of the necessity of allowing borrowing in certain circumstances and of its usefulness in others. Building on such awareness, gradually the idea gained consensus that the public debt need not be repaid as it can be refunded and that “the problem of the debt burden is a problem of an expanding national income. How can a rapidly rising income be achieved?” (Domar, 1944, p. 166).This paper aims at providing a concise overview of the main issues surfacing the debate over public debt. In Section 1 we review the main economic factors explaining the existence of debt from three perspectives: public finance, monetary policy and political economy. Section 2 takes a positive point of view and is dedicated to the definition of debt sustainability and to the analytical tools available to undertake its assessment. Section 3 discusses the implications of high debt levels for the macroeconomic performance of the economy. Section 4 turns normative and considers market and rule-based mechanisms to control debt growth. Section 5 and 6 are devoted to more technical aspects concerning both analysis and policy: the former examines the issues arising when measuring public liabilities, the latter considers how fiscal rules and indicators can affect government debt management.