1. Restricted 1 The Future of Public Debt: Prospects and Implications Stephen Cecchetti * Economic Adviser and Head Monetary and Economic Department Bank for International Settlements First International Research Conference, Reserve Bank of India 12-13 February 2010 * Views expressed here are those of the author and do not necessarily reflect those of the BIS. 1

2. 2 Cecchetti The problem Public debt is rising sharply in advanced countries Debt-to-GDP ratios of 100% is becoming common Should we care? Post-WWII debts above 100% of GDP were common (examples: US 120%, UK 300%) Japan has been living with high debt for years The last industrial countries to default were WWII losers

3. 3 Cecchetti Things are not as they seem Consolidation is difficult when Interest rates are poised to increase Growth rates are unlikely to rise Even when consolidation occurs, it stabilises debt to GDP The long run is much worse Populations are aging. Unless policy changes debt will rise to 3+ times its current levels Problem needs to be addressed now.

4. 4 Cecchetti Outline Current facts The trajectory Challenges for policymakers

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8. 8 Long-term fiscal imbalances Age-related spending is exploding Focus on short-term is incomplete and misleading Concerns about fiscal sustainability & intergeneration equity: present value of unfunded commitments should be reflected

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10. 10 Cecchetti Debt-to-GDP Projections 30 years and 12 countries Baseline: Revenue and non-age related expenditure constant at 2011percentage of GDP Real interest rate at 1998-2007 average Potential growth at OECD post-crisis level Gradual adjustment: Primary deficit improves 1pp of GDP per yr for 5 yrs Gradual adjustment + freezing age-related spending to GDP at 2011 level Results Graph 4

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13. 13 Cecchetti Risks and risk premia Higher debt increases the possibility unstable dynamics So, higher debt means a bigger risk premium We plot CDS spreads against Debt to GDP Government revenue to GDP Share of short-term debt Incremental debt to private saving

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15. 15 Cecchetti Debt and fiscal policy Higher taxes create greater distortions Higher debt can mean higher real interest rates Reduced effectiveness in responding to shocks All of this can lower the long-run growth path

16. 16 Cecchetti Debt and monetary policy Inflation expectations Forecast uncertainty

17. 17 Cecchetti Conclusions Current estimates of public debt ignore the big problem: age-related expenditure High debts have significant real and financial consequence Action is needed now.