Britain’s debt-to-GDP ratio is set to rise from 84% last March to more than 100% this fiscal year
DO HIGH LEVELS of public debt reduce economic growth? Many economists asked that question after the financial crisis of 2007-09, when bank bail-outs and fiscal-stimulus programmes caused debt-to-GDP ratios to surge across developed countries. In 2010 two Harvard economists, Carmen Reinhart and Kenneth Rogoff, came up with an eye-catching answer. Taking data for 44 countries across two centuries they found that economic growth falls by roughly half when public debt exceeds 90% of GDP.
Many historians suggest policymakers should not be too worried about high levels of debt in some advanced economies. Britain’s debt-to-GDP ratio, for instance, is set to rise from 84% last March to more than 100% this fiscal year. That is high by modern standards, but not unprecedented. By the end of the Napoleonic wars, in 1815, Britain’s national debt stood at nearly 200% of its GDP; it slid to 25% by 1914. After the second world war it reached 259%, and America’s 112%.
This chimes with IMF research that suggests, in the long term, it is the direction of the debt-to-GDP ratio, rather than its level, that matters most for growth. The authors of onepublished in 2014 found, like Ms Reinhart and Mr Rogoff, that growth in GDP per person is slower in countries with debt-to-GDP ratios above 90%—if the data are looked at year-by-year.
How can countries reduce their debt-to-GDP ratios over the long term, as America and Britain have in the past? Whether the post-second world war experience can be repeated is questionable, as our recenton public debt pointed out. Some 70% of the reduction in Britain’s debt-to-GDP ratio between 1946 and 2008 was because of inflation.
In the long term governments may rely on economic growth—or, to be precise, growth that exceeds interest rates—to reduce their debt-to-GDP ratios. That would be similar to what happened in Britain after the Napoleonic wars. Britain did not inflate away its debts or run budget surpluses to pay them down . Instead, the compounding effect of real economic growth reduced the weight of the debt burden.
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