Global Debt

Issue

Since the global financial crisis of 2008-2009, governments’ spent in advanced economies have exceeded their tax receipts, resulting in a massive amount of budget deficits, therefore they financed their deficits by issuing government debt. Most of the governments have chosen to reduce and even eliminate their deficits using fiscal austerity programs. The issue arose from this phenomenon, whether this policy will undermine the weak recovery from global financial crisis, and whether more reforms are required to lower the debt levels.

Background

• Concerns about high levels of public debt have been most focused on three Eurozone countries (Greece, Ireland, and Portugal) since late 2009, who have turned help to the IMF and other European governments for financial assistance in order to avoid defaulting on their loans.

• There are also concerns about the sustainability of public finances in Spain, Italy, U.S., Japan, and the U.K.

• Many advanced-economy governments have embarked on fiscal austerity programs (e.g. cutting spending and/or increasing taxes) to address historically high levels of debt.

• Congress are concerned about if U.S. public debit crisis tend to become similar to some Eurozone countries, or they are still in a stronger position with far less risky.

Economic Analysis

• The IMF has identified advanced economy debt as a possible threat to the global economic recovery, as countries struggle to find a balance between growth and debt management in an uncertain global economic recovery.

• Fiscal debates are focusing on a number of budget and debt issues, compared between the U.S. and other advanced economies (e.g. Greece, Ireland, and the U.K.)

• The way the other countries used to reduce their debt influences the U.S. economy.

• For the fourth quarter of 2012, a research firm CMA estimated the likelihood of the United States defaulting on its debt over the next five years to be 3.30%, and ranks the United States as the fifth least-likely country to default. By contrast, Cyprus, Portugal, and Spain are ranked the top 10 countries most likely to default.

• Government borrowing can help stimulate the economy during a recession or fund long-term investment projects that increase economic output in the future. Whereas, governments may be reluctant to increase taxes or cut spending during economic booms in order to pay off debt incurred during economic downturns, leading to growing debt levels over time. Moreover, government borrowing for consumption purposes can create difficulties when it dues the debt obligation, because it does not yield future economic benefits.

Risk Analysis

• The implement of fiscal austerity programs in most advanced economies to lower their debt levels, could slow growth in advanced economies and depress demand for U.S. exports abroad, as well as deter investment in and from advanced economies.

• Defaults and debt crises can be triggered by a number of different economic and political factors, including, but not limited to, economic recessions, fluctuations in the price of imports and exports, currency depreciation (if debt is not payable in domestic currency), wars, and changes in political leadership.

• The rise in sovereign debt among advanced economies during the financial crisis is only the start of more serious debt problems to come, e.g. aging populations in many advanced economies will cause public debt to skyrocket, as a shrinking workforce will result in lower tax revenue while more retirees will require an increase in government spending on pensions and healthcare.

• High public debt levels in advanced economies make governments vulnerable to unexpected and quick changes in investor behavior.

• Government competition for loans can increase interest rates when the economy is at full employment, causing private investment to fall.

• High debt levels restrict the ability of the government to respond to unexpected crises, such as natural disasters.

Option Analysis

• Available options:

(1) Fiscal consolidation (most frequently used): policies that reduce the government budget deficit, including tax increases, spending cuts, or some combination of the two.

(2) Debt restructuring: reorganizing a debt that has become too large and burdensome for the borrower to manage.

(3) Inflation: if sovereign debt is denominated in the domestic currency, the government can use inflation to reduce the real value of the debt.

(4) Growth: economic growth also allows governments to lower the size of their debt relative to the size of their economy.

(5) Financial repression: using government policies to induce or force domestic investors to buy government bonds at artificially