Reducing Public Debt: The Experience of Advanced Economies over the Last 70 Years

Abstract

This paper investigates the episodes of public debt reduction in advanced economies since the Second World War. We find 30 episodes of large reductions in the public debt-to-GDP ratio. Four main approaches succeeded in lowering the debt ratio. First, after the end of WWII, high and unexpected inflation eroded a large share of public debt. Second, during the Bretton Woods era, a mix of financial repression, high economic growth and moderate inflation helped reducing public debt. Third, since the 1980s, several advanced economies followed orthodox fiscal adjustments, namely improving their primary balance by reducing expenditure and/or raising taxes. The fourth approach (debt restructuring) was implemented only in one case: Greece in 2011-12. One key finding of our paper is that debt reduction has never been achieved by relaxing fiscal policy (cutting taxes or increasing expenditure), hoping that this would set in motion a growth process sufficiently strong to lower the debt ratio (the so-called “denominator approach” which has recently become fashionable in some countries, including Italy). The empirical evidence of the last 70 years suggests that running a sufficiently strong primary surplus is the only viable option to reduce public debt ratio nowadays, particularly in countries that are part of the euro area.