The Determinants of the Interest-Rate–Growth Differential

Abstract

This chapter examines the state of fiscal accounts in advanced and emerging market economies from the postwar period until the outburst of the 2007 financial crisis, revealing some early symptoms of fiscal profligacy that eventually degenerated into fiscal stress. In G7 countries, general government expenditures grew persistently, from 25 percent of GDP in 1950 to 40 percent in the early 1990s. Initially, increasing expenditures were paid for by increasing revenues, but these were eventually accommodated by wider deficits and growing debt. After reaching a postwar low of 35 percent of GDP in the mid-1970s, helped by a negative interest-rate growth differential, the debt-to-GDP ratio stood at 84 percent by the time the crisis erupted. The reduction in fiscal deficits in advanced economies just before the crisis reflected largely temporary factors: equity prices added about 1.5 percent of GDP to revenues in advanced G20 countries, while housing prices, at their peak prior to the crisis, improved revenues in several European Union countries by about 2 percent of GDP.