George Osborne’s obsession with reducing Britain’s debt mountain may do more harm than good, research by the International Monetary Fund (IMF) has suggested.
While advanced nations are facing some of the highest debt ratios since World War II, IMF economists cited research by Moody’s Analytics that suggested countries such as the UK, US and Canada could afford to live “forever” with relatively high debt shares compared with their pre-crisis averages.
The IMF paper, which was authorised by Olivier Blanchard, the Fund’s chief economist, showed that while countries such as Greece, Cyprus, Italy and Japan had a pressing need to reduce their debt ratios because of the risk that a financial shock could leave them shut out of the market, others such as Norway, Germany and the UK were deemed to be in the “safe zone”, where fiscal space was ample and borrowing costs were low.
In countries such as the UK and Norway which controlled their own monetary policy, the advantages were even bigger, the authors said.
For these countries, the IMF said the “optimal” policy involved “living with high debt pile[s]”. While the Fund said this was far from ideal, it was preferable to introducing “policies to deliberately pay down the debt” because the costs were likely to outweigh the benefits.
“When a country runs a budget surplus to pay down its debt, there is no free lunch, the money has to come from somewhere,” said Jonathan Ostry, co-author of the report. “Either through higher taxes, which undercuts the productivity of labour and capital, or lower spending which – unless that spending is completely wasteful – has a similar effect.
“Advocates of ‘fixing the debt problem’ stress that the crisis insurance benefit of lower debt without mentioning the upfront cost of the insurance. Our paper shows that insurance can be expensive.
“More importantly, for countries that have ample fiscal space, the cost of insurance is likely to be much larger than the benefit. It is much better in these circumstances to just live with the debt, allowing the debt ratio to be reduced organically through higher growth.”
Britain’s debt share currently stands at 80.4pc of gross domestic product (GDP) but is on course to start falling this year. The Chancellor announced a series of measures in the Budget, including the speeding up of asset sales, to help Britain’s debt ratio fall faster.
The government is also planning a £25bn spending squeeze, including a £12bn reduction in welfare spending, which is expected to be announced in detail on July 8 when Mr Osborne delivers his Summer Budget. This will put the UK on course to eliminate the budget deficit by the end of the decade, and reduce Britain’s debt share.
However, Moody’s, the rating agency, has warned that the Government will struggle to balance the books by the end of the decade because of the scale of cuts required and the likelihood that the easiest reductions have now been made.
Economists are split over the best way to secure the recovery in the wake of the financial crisis. While Larry Summers, the former US Treasury Secretary, has warned that of the perils of secular stagnation, Ken Rogoff, who also served as the IMF’s chief economist a decade ago, has said that growth will be stronger once deleveraging and borrowing headwinds subside.
The IMF said that countries with ample fiscal space should focus on beefing-up infrastructure, where the rewards could be big. “For countries with low debt and big infrastructure needs (and with idle resources and facing low interest rates), building infrastructure should be the greater priority. For countries with significant risk of fiscal distress, it is unlikely that they could afford to take the chance of going on a borrowing spree, no matter how large the public investment,” the report said.
However, the IMF said a higher starting point of debt compared with the financial crisis meant returns on investment were likely to be lower than they were in the run-up to 2008.
Britain is forecast by the Office for Budget Responsibility (OBR) to pay £46bn in gross debt interest payments this year on its debt pile of £1.48 trillion.