Public debt
6 The unexplained part of public debt
When working with real-world data, sometimes the left- and right-hand sides of Equation 7 don’t match. The statistics published by the government for \(∆b\) may be larger or smaller than one would expect from the values of \(d\), \(i\), \(π\), \(g\) and \(b_{t-1}\). This can happen because the deficit and interest payments are flows (they are measured over a period of time), whereas debt is a stock (it is measured at a point in time).
Public-debt analysts accommodate this fact by appending another term to the equation:
\[\begin{align*} \text{Δ}b &= d + (i - π - g)b_{t - 1} + sf &&(8) \end{align*}\]The term ‘off-budget resources’ refers to expenditures that are not included in the government budget. For instance, the government may set up a special entity to borrow money for a particular task (such as to finance bank recapitalization or a specific investment project). Since borrowing is not done directly by the government, it is often not included in the government budget. There are cases, however, in which the government needs to borrow directly to recapitalize such off-budget entities and this borrowing can lead to sudden jumps in public debt which are not reflected in budgeted public expenditures. For details, see ‘Underground Government: The Off-Budget Public Sector’ by James Bennett (2004).
The stock-flow reconciliation is represented by sf. This cumbersome name comes from the fact this residual item exactly reconciles the deficit, interest payments, and the change in GDP with the stock of debt. This term is also referred to as ‘the unexplained part of public debt’.
Equation 7 works well enough, obviously, when such discrepancies are small. At times, however, they can be large. This will be the case, for example, when a banking crisis forces the government to use off-budget resources to inject funds into the banking system, or when it recapitalizes a large state-owned corporation. It can be the case when public debt is denominated in foreign currency and the exchange rate depreciates, causing the value of the debt to shoot up relative to GDP (which is denominated in domestic currency). ‘Find out more: The case of COVID-19’, where we use Equation 8 to decompose the increase in debt ratios during the COVID-19 pandemic, shows that this reconciliation can be important in practice.
Find out more The case of COVID-19
Governments around the world increased public spending and ran substantial budget deficits in response to the COVID pandemic, leading to sharp increases in debt-to-GDP ratios. In the advanced economies, debt-to-GDP ratios rose from about 100% in 2019 to more than 120% in 2020. In emerging and developing economies, ratios went from an average of 54% to 63% (see Figure 8).
Figure 9 uses Equation 8 to decompose the growth of the debt ratio into the contributions of the primary deficit, interest payments, inflation, real GDP growth (in this case, negative growth), and the stock-flow reconciliation. The variables above the zero line increased the debt-to-GDP ratio, while the variables below the line reduced it. The figure shows that the two main drivers of the increase in the debt-to-GDP ratio were the increase in deficits and contraction of GDP. The red bars show that the primary deficit added 10 percentage points to the debt ratio in the advanced economies and 7.5 percentage points in emerging and developing economies.
Negative growth (the blue bars) also contributed to the increase in the debt-to-GDP ratio, where the effect was again larger in the advanced economies. Note that if growth had been positive instead of negative, the blue bars would have been in the bottom part of the graph. This difference reflects two elements. Firstly, the GDP contraction was smaller in emerging and developing economies (2 percentage points versus nearly 5 percentage points). Secondly, the initial level of debt was smaller in emerging and developing economies (remember that, in Equation 8, GDP growth is interacted with the initial debt/GDP ratio). In particular, the contribution of negative growth to the increase in the debt ratio is high in Latin America both because the recession was deeper than in other emerging economies and because the initial debt level was higher.
Finally, in all regions inflation played some role in mitigating the growth of debt.
![In this bar chart, the horizontal axis shows seven regions or types of economies, and the vertical axis shows the debt-to-GDP ratio as a percentage, ranging from 0 to 140. In 2019, the debt-to-GDP ratio was around 105% in advanced economies, 56% in emerging and developing economies, 58% in developing Asia, 30% in developing Europe, 70% in Latin America, 50% in the Middle East, and 52% in sub-Saharan Africa. In 2020, the debt-to-GDP ratio was 122% in advanced economies, 62% in emerging and developing economies, 64% in developing Asia, 38% in developing Europe, 78% in Latin America, 56% in the Middle East, and 58% in sub-Saharan Africa.]()
Figure 8 Debt-to-GDP ratio in advanced and emerging economies.
Authors’ elaborations based on IMF Data.
![In this bar chart, the horizontal axis shows seven regions or types of economies (advanced economies, emerging and developing economies, developing Asia, developing Europe, Latin America, Middle East, and Sub-Saharan Africa). The vertical axis shows five measures: negative real GDP growth, inflation, interest payments, the primary deficit, and the stock-flow reconciliation, expressed as contribution to the debt-to-GDP ratio in percentage points, ranging from negative 10 to 25. For all regions and types of economies, negative GDP growth, primary deficits, and interest payments contributed to the debt-to-GDP ratio, while inflation helped reduce the debt-to-GDP ratio. In all regions except for Developing Asia, the stock-flow reconciliation reduced the debt-to-GDP ratio.]()
Figure 9 Drivers of the increase of the debt-to-GDP ratio over 2019 to 2020.
Authors’ elaborations based on IMF Data.
