IMF World Economic Outlook Report- Chapter 3 and 4

Summary Chapter 3: The Good, the Bad, and the Ugly: 100 Years of Dealing with Public Debt Overhangs Public debt in advanced economies has climbed to its highest level since World War II. Debt consolidation is further exacerbated by low growth, persistent budget deficits, weak financial sectors, contingent liabilities due to rapidly ageing populations and a weak external environment. Successful debt reduction requires fiscal consolidation and a policy mix that supports growth. Key elements of this policy mix are measures that address structural weaknesses in the economy and a supportive monetary policy stance. Fiscal consolidation must emphasize persistent, structural reforms to public finances over temporary or short-lived fiscal measures. In this respect, fiscal institutions can help lock in any gains. Public debt levels above 100 percent of GDP are not uncommon. Of the 22 advanced economies analysed, more than half experienced at least one high-debt episode between 1875 and 1997. Furthermore, several countries had multiple episodes: three for Belgium and Italy and two for Canada, France, Greece, the Netherlands, and New Zealand. The episodes are clustered around four major eras: the last quarter of the 19th century, the periods following the two World Wars, and the last quarter of the 20th century. The 19th century debt buildup was related mainly to nation building and the railroad boom. The post World War II episode is connected with an enormous and widespread military effort and subsequent rebuilding, although some start earlier, during the Great Depression. The episodes in the last cluster during the 1980s and 1990s have their genesis in the breakdown of the Bretton Woods system, when government policy struggled with social issues and the transition to current economic systems. The largest debt reductions followed in the period after the World Wars, usually as a result of hyperinflation. The United States (1946) stands out as an exception; however, inflation was still an important contributor to debt reduction during this episode. The framework used for the analysis of debt-to-GDP in the paper takes into account four variables; the interest rate paid on the stock of debt, the inflation rate on the GDP deflator, the real GDP growth rate and the primary deficit-to-GDP ratio. 1/3

The IMF argues that there is no clear correlation between growth and debt reduction in this group of high-debt episodes. Historical experience suggests that countries dealing with high debt burdens are unlikely to experience strong improvements in their debt ratios while real rates are high and monetary conditions remain tight. Assuming that sufficiently supportive monetary conditions can be achieved, the IMF finds that fiscal policy focused on permanent or structural reforms appears to provide larger and more enduring debt reductions than do policies based on more temporary measures. Chapter 4: Resilience in Emerging Market and Developing Economies: Will It Last? The chapter examines the evolution of output per capita in more than 100 emerging market and developing economies over the past 60 years. It identifies periods of expansion, downturn, and recovery in their output paths. The IMF analyses how these durations have changed over time and how they relate to various shocks, policies, and structural characteristics. The main findings are: o The resilience of emerging market and developing economies has increased markedly during the past two decades. They are spending more time in expansion, and downturns and recoveries have become shallower and shorter. The past decade was the first time that emerging market and developing economies spent more time in expansion, and had smaller downturns, than advanced economies. o Various shocks, both external and domestic, can negatively impact expansions in these economies. Among the external shocks; sudden stops in capital flows, advanced economy recessions, spikes in global uncertainty, and terms-of-trade busts all increase the likelihood that an expansion will end. While domestic shocks such as credit booms double and banking crises triple the probability that an expansion will shift into a downturn by the following year. o Good policies facilitate increased resilience. Specifically, greater policy space characterized by low inflation and favorable fiscal and external positions and improved policy frameworks (countercyclical policy, inflation targeting, and flexible exchange rate regimes) are associated with longer expansions and faster recoveries. o It is more difficult to tease out the effects of resilience on these economies structural characteristics such as trade patterns, financial openness and the composition of capital flows, and income distribution. Few of these characteristics are robustly associated with the duration of expansions and the speed of recoveries. o Improvements in policymaking and the buildup of policy space in many of these economies account for the bulk of the increased resilience since 1990. Some shocks, such as spikes in global uncertainty, have become more frequent in the past decade, but other shocks have become less frequent, such as banking crises and credit booms.

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Overall, the fact that there have been fewer shocks accounts for about two-fifths of the improved performance in emerging market and developing economies. Greater policy space and better policy frameworks account for the remaining three-fifths of the improvement in their performance.

Should the external environment worsen again, emerging market and developing economies will likely end up recoupling with advanced economies, as much as they did during the Great Recession. Even in the absence of an external shock, homegrown shocks could pull down growth further in some key emerging economies. To guard against such risks, these economies will need to rebuild their buffers to ensure that they have adequate policy space. In response to the global downturn, policy space was rightly used to support activity. These economies will be more resilient to new shocks if recent improvements in their policy frameworksincluding greater exchange rate flexibility and more countercyclical macroeconomic policiesare maintained, while policy buffers are being rebuilt.

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