Achieving prudent debt targets using fiscal rules Rencontres economiques d'Aix-en-Provence 3 July 2015

1. ACHIEVING PRUDENT DEBT
TARGETS AND FISCAL RULES
Catherine L. Mann
OECD Chief Economist
Aix-en-Provence
3 July 2015
http://www.oecd.org/eco/achieving-prudent-debt-targets-using-fiscal-rules.htm

2. • OECD average gross government debt increased by 36 percentage
points from 2007 to 2013 to reach 110% of GDP.
2
Rising government debt raises concerns
0
50
100
150
200
Per cent GDP
2007 2013
Source: OECD (2014), "OECD Economic Outlook No. 96", OECD Economic Outlook: Statistics and
Projections (database).

3. • Three questions:
– How should a government debt target be set?
– What should be the prudent debt-to-GDP
ratio countries should target over the medium
term?
– How can fiscal frameworks be designed to
achieve prudent debt targets while providing
scope to respond to the economic cycle?
3
Designing debt targets and fiscal
frameworks

4. 4
Limits to debt sustainability

5. • Debt limits cannot be the anchor of prudent debt targets
5
Sustainability limits may look high, but
countries should steer clear of them
0
50
100
150
200
250
300
350
% GDP Gross debt in 2013 Debt limit (model based interest rate) Debt limit (current interest rate)
Source: Fournier and Fall (2015)

6. • The debt threshold takes into account:
• the impact of debt on growth,
• the effectiveness of fiscal policy,
• and the link between debt and the provision of public
infrastructure.
– It seems that gross debt above about 80% of GDP
has detrimental consequences.
• More precisely:
• Advanced economies debt threshold: 70-90% of GDP
• Euro area countries debt threshold: 50-70% of GDP
• Emerging economies debt threshold: 30-50% of GDP
6
Defining a debt threshold as the anchor of
prudent debt targets

7. • A stochastic debt analysis was performed.
• The cushion that is needed to stay below debt thresholds
in the case of adverse shocks was calculated.
• The prudent debt target is the median debt by 2040 such
that there is less than a 25% risk to go beyond the debt
threshold.
7
Designing prudent debt targets

8. 8
Country by country prudent debt targets
Prudent debt levels
Average annual fiscal effort (primary balance surplus) by 2040
0
25
50
75
100
125
150
GRC
IRL
SVK
FIN
PRT
SVN
NLD
ESP
DEU
BEL
FRA
ITA
AUT
JPN
CAN
ISR
POL
USA
GBR
Per cent of GDP
0
1
2
3
4
5
6
7
GRC
IRL
SVK
FIN
PRT
SVN
NLD
ESP
DEU
BEL
FRA
ITA
AUT
JPN
CAN
ISR
POL
USA
GBR
Per cent of GDP

9. • The role of the prudent debt target: effective in anchoring
expectations about future fiscal policy. The prudent debt target
serves as the reference point to define numerical fiscal rules.
• Fiscal rules:
– Role: Promote fiscal discipline and long-term growth (well-
being).
– Objectives: (1) Anchor fiscal policy expectations by targeting a
prudent debt level and (2) allow for macroeconomic
stabilisation.
– Challenge: The trade-off between reducing recession risks and
debt trajectory uncertainty.
9
Designing effective fiscal frameworks

10. Budgetbalance Structuralbalance Expenditurerule Revenuerule
Fiscalstabilisation - + + -
Fiscaldiscipline ++ + + -+
Side-effectsandrisks - -- - -
Benchmarking existing rules
• The adoption of a budget balance rule complemented by
an expenditure rule is promising.
• A budget balance rule ensures hitting the debt target.
• And, well-designed expenditure rules ensure the
effectiveness of a budget balance by limiting pro-
cyclicality and too dynamic spending.

11. Panel A. GDP growth (%) Panel B. Primary balance (% of GDP) Panel C. Public debt (%)
11
Comparing past behaviour and budget balance rule +
spending rule: the example of France

12. 0
5
10
15
20
25
30
35
Group 1 Group 2 Group 3 Group 4 Group 5 Group 6
Per cent
Constant primary balance Automatic stabilisers Additional stimulus
Spending rule Include interest payments Debt rule
0
5
10
15
20
25
30
35
40
45
Group 1 Group 2 Group 3 Group 4 Group 5 Group 6
Per cent GDP
Panel B. Debt level uncertainties
Panel A. Long-term recession risks
AUS, ISR, KOR, NZL,
POL, CHE , USA
CAN, CZE ,
SVK
DNK, LUX,
SWE, GBR
AUT, BEL, FIN, FRA,
DEU, NLD, SVN
GRC, IRL, ITA,
PRT, ESP
JPN

13. The trade-off between counter-cyclicality and
hitting the debt target
Strict primary balance rule: target is constant
Rule allowing automatic stabilisers to operate
FRA
GBR
DEU
USA
JPN
ESP
0
5
10
15
20
25
30
35
40
0 10 20 30 40 50
Debt ratio uncertainties (% of GDP)
Long-term recession risks (%)
0
5
10
15
20
25
30
35
40
0 10 20 30 40 50

14. • Debt thresholds for groups of countries:
• For higher-income countries, a debt threshold range of 70 to
90% of GDP.
• For euro area countries, the debt threshold is lower at 50-70%
• Emerging economies have a debt threshold at 30 to 50%
• The average prudent debt target which minimise the probability
of hitting the threshold is 15 percentage points lower than the
threshold.
• The fiscal framework should have two objectives: ensuring fiscal
discipline and permitting stabilisation policies.
• A combination of a budget balance rule and an expenditure rule
suits most countries well:
• A budget balance rule encourages hitting the debt target.
• And, well-designed expenditure rules appear decisive to
ensure the effectiveness of a budget balance rule and can
foster long-term growth.
Main messages

15. 15
Further information
Disclaimers:
The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of
such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in
the West Bank under the terms of international law.
This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the
delimitation of international frontiers and boundaries and to the name of any territory, city or area.
Fall, F., D. Bloch, J.-M. Fournier and P. Hoeller (2015), “Prudent Debt Targets
and Fiscal Frameworks”, OECD Economic Policy Papers, No. 15, OECD
Publishing, Paris.
Bloch, D. and F. Fall (2015), "Government Debt Indicators: Understanding the
Data", OECD Economics Department Working Papers, No. 1228, OECD
Publishing.
Fournier, J-M. and F. Fall (2015), "Limits to Government Debt Sustainability",
OECD Economics Department Working Papers, No. 1229, OECD Publishing.
Fall, F. and J-M. Fournier (2015), "Macroeconomic Uncertainties, Prudent
Debt Targets and Fiscal Rules", OECD Economics Department Working
Papers, No. 1230, OECD Publishing.

16. THANK YOU
16