High debt doesn’t hurt economic growth: IMF

Austerity advocates, including the UK’s George Osborne, have used previous research to justify focusing on debt reduction, but a new paper says medium and long-term growth isn’t necessarily impacted. EPA/Stefan Rousseau

High levels of government debt won’t hurt economic growth in the medium and long-term, according to a new paper released by the International Monetary Fund.

The research findings contradict earlier arguments that high debt is a constraint on growth.

Monash University’s Rodney Maddock said the findings were a “good antidote to some of the feverish debate about debt that had been going on internationally”.

“An economy which is growing quickly and has an effective government, like China, can easily service high levels of debt. Countries like Greece and Italy, with high debt, slow growth and ineffective governments are hardly likely to attract much lending even at rates above those in China,” he said.

Last year former BHP Billiton and National Australia Bank chief Don Argus warned high debt was “dragging us down”, echoing comments by leading Coalition figures including Andrew Robb and Joe Hockey.

The IMF paper found that growth performance for countries with government debt above 90% of GDP was “quite diverse”. It said it was “equally possible that increases in public debt above 90% are driven by an omitted variable that reduces GDP and tax revenues that, in turn, leads to higher debt”.

Fabrizio Carmignani, a professor of economics at Griffith Business School, said one of the critical points in the contradictory positions was the quality of the data and how many countries were covered over what time period.

“Unfortunately this is one of those areas in economics where the results are sensitive to changes in methodology, type of data and sample used for estimation. You don’t need to change much to have relatively different results,” he said.

Previous research, in particular the influential “Growth in a Time of Debt” paper, published in the American Economic Review in 2010, found that “when external debt reaches 60% of GDP, annual growth declines by about 2%; for higher levels, growth rates are roughly cut in half.”

That hypothesis has come under criticism in the past for “unorthodox methodological choices”.

But the paper, authored by prominent economists Carmen M. Reinhart and Kenneth S. Rogoff, had been widely cited by politicians, including the UK’s Chancellor of the Exchequer George Osborne, to advocate for austerity following the global financial crisis.

Professor Carmignani said while the Reinhart-Rogoff paper had often been used to justify fiscal austerity policies in the short term, the research was really about the long-term effect of high debt.

“The media says [the paper] related to austerity, but if you read it, you don’t find the justification for the kind of austerity rolled out across Europe and that’s a point that has been overlooked,” he said.

Another approach

Making sure there wasn’t a structural deficit is more important than the debt-to-GDP ratio, according to Phil Lewis, a professor of economics at the University of Canberra.

“In the normal course of the economic cycle, governments will go between deficit and surplus. But if the economy is at full employment it shouldn’t be in debt because if you have a recession there will be less flexibility to put in place policies to react,” he said.

Monash University economics professor Jakob Madsen pointed to Greece as an example of inflexibility. He said if the debt-to-GDP level was 100% and an external shock sent interest rates up by 10%, it would be “virtually impossible” to cover the additional payments.

The new IMF paper also found that while there was an association between debt and growth at the “shortest-term relationship”, it was the trajectory of debt that had a better relationship with growth over a longer term.

“Countries with high but declining levels of debt have historically grown just as fast as their peers,” the researchers wrote.