Fiscal Anatomy of Two Crises and an Interlude

FiscalAnatomyofTwoCrisesandanInterlude XuehuiHan,PaoloMauro,andJohnRalyea WP/23/117 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 JUN ©2023InternationalMonetaryFundWP/23/117 IMFWorkingPaper FiscalAffairsDepartment FiscalAnatomyofTwoCrisesandanInterludePreparedbyXuehuiHan,PaoloMauro,andJohnRalyea* AuthorizedfordistributionbyPaoloMauro June2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:TheGlobalFinancialCrisis(GFC)andtheCOVID-19pandemicareassociatedwiththelargestincreasesinpublicdebtratiossinceWorldWarII.Wedecomposeunexpectedchangesindebtratiosintotheroleofsurprisesineconomicgrowth,interestcosts,policymeasures,andotherfactors.Duringbothcrises,lower-than-expectedoutputcontributedthemosttohigher-than-expecteddebtratios.Fiscalpolicymeasuresrecordedinthepublicdeficitweresimilarinthetwoepisodes.Wealsoanalyzethedecade-longinterlude(2010-19).Ratherthandecliningasforeseeninanormativescenario,debtratiosremainedstableonaverage,asinterestrates,policyadjustmentand,insomecountries,economicgrowthturnedoutlowerthanexpected. RECOMMENDEDCITATION:Han,Xuehui,PaoloMauro,andJohnRalyea.2023.“FiscalAnatomyofTwoCrisesandanInterude.”IMFWorkingPaper2023/117.InternationalMonetaryFund,Washington,DC. JELClassificationNumbers: H12,H62,H63,H68 Keywords: CrisisManagement;Publicdebt;Deficit;Forecasts Author’sE-MailAddress: xhan@imf.org;pmauro@imf.org;jralyea@imf.org; *TheauthorsaregratefultoVitorGasparandotherparticipantsinseminarsintheIMF’sFiscalAffairsDepartment. WORKINGPAPERS FiscalAnatomyofTwoCrisesandanInterlude PreparedbyXuehuiHan,PaoloMauro,andJohnRalyea Contents Introduction3 DebtDevelopmentsDuringtheGlobalFinancialCrisisandtheCOVID-19Pandemic4 DriversBehindSurpriseChangesinDebt6 DebtSurprisesDuringtheGFCandCOVID-19Pandemic7 Driversofdebtsurprisesin2009and2020inindividualG20countries8 TheRoleoffiscalmeasuresindebtdynamicsduringtheGFCandCOVID-19crises10 TheInterlude(2010-19)11 Decompositionofdebtsurprisesforadvancedeconomies12 DebtdevelopmentsandPolicyMeasuresVersusNormativeRecommendations14 PolicyDiscussions15 References22 FIGURES 1.GlobalGeneralGovernmentDebt5 2.GrossDebtandInterestExpense5 3.EconomicRecessionsinG20Countries7 4.DriversofDebtSurprises:GFCandCOVID-198 5.G20:CompositionoftheUnexpectedChangeinDebtin20099 6.G20:CompositionoftheUnexpectedChangeinDebtin20209 7.DiscretionaryFiscalPolicy:GFC(2009)andCOVID-19Pandemic(2020)10 8:EstimatesofDiscretionaryFiscalPolicyDuringtheGFCandCOVID-19Pandemic11 9.AdvancedEconomies:DecompositionofCumulativeDebt‘surprise’for2010-201912 10.DecompositionofLower-than-expectedDebtRatiosfor201913 11.DecompositionofHigher-than-expectedDebtRatiosfor201914 12.AdvancedEconomies:RecommendedandActualFiscalAdjustment,2010-1915 ANNEXES I.AnalyticalFrameworkandSensitivitytoElasticityAssumptions17 II.RobustnessCheckoftheMagnitudeoftheCrisisFiscalPolicyMeasures19 III.EvolutionofAdvancedEconomies’MacroeconomicandFiscalAggregates21 Introduction TheGlobalFinancialCrisis(GFC)thatbeganin2008andtheCOVID-19pandemicthatbeganin2020havebeenassociatedwiththelargestincreasesinpublicdebtratiossinceWorldWarII.Duringtheinterveningperiod(the“interlude”),debtratioswerebroadlystableorrising,sothatthepandemicledtoanotherstepincreasebeyondthelevelsreachedbecauseoftheGFC.Thetwocrisesweredifferentinsource(financialversushealth-related),incidenceacrosscountries(theGFCbeingmoreconcentratedinadvancedeconomiesandthuslessglobal,despiteitsname),andthecausesanddurationoftheassociatedrecessions(thepandemicbeingfollowedbyafasterreboundofeconomicactivity).Evenso,analyzingthefactorsthataccountedfortheunexpectedriseinpublicdebtratiosduringthesetwocrisesandtheinterveningperiodmayshedlightonthepathssuchratiosmaytakeinthenextdecade,andtherolethatpoliciescanplayinthatevolution. Inthispaper,wedecomposeunexpectedchangesindebtratiosintotheroleofsurprisesineconomicgrowth,interestcosts,policymeasures,andresidualfactorssuchasexchangeratedepreciationsandthefiscalcostofbailouts.1Weconsiderthefullimpactofeconomicgrowthnotonlythroughthedenominatorinthedebt/GDPratiobutalsoaskeydriveroffiscalrevenuesandthustheprimarysurplus. Tocapturetheeffectsofthetwocrises,wecomparemacroeconomicandfiscaloutcomes(asmeasuredtoday)for2009(GFC)and2020(pandemic-relatedeconomiccrisis)withprojectionsmadejustbeforetheseverityoftheGFCandtheCOVID-19crisiswereunderstoodbymostanalysts(October2008andJanuary2020vintagesoftheIMF’sWorldEconomicOutlookprojections,respectively).Wealsoanalyzethedecade-longinterlude(2010-19),bycomparingoutcomesmeasuredtodaywith(a)projectionsmadein2010(AprilvintageoftheIMF’sWorldEconomicOutlook)and(b)anormativescenariothatIMFstaff(CottarelliandVi