The world’s most developed economies, which have been racking up spending since the mid-1960s, face record levels of debt as a result of the 2008-9 financial crisis and have little room for maneuver, the International Monetary Fund warned on Wednesday.
Despite the stark warning and the prospect that the wealthiest nations face years of belt-tightening, the fund also said that the risk of default by heavily indebted European countries like Greece, Ireland and Portugal had been significantly overestimated.
In three new research papers, the fund’s economists offered stern admonitions while cautioning against an overreaction.
That mix of messages was reflected in one paper on the long-term trends in the public finances of the Group of 7 economies.
The authors, Carlo Cottarelli, director of fiscal affairs, and Andrea Schaechter, a senior economist, concluded that public debt had served for decades as “the ultimate shock absorber — rising in bad times but not declining much in good times.”
As their populations age, rich countries will face more financial pressure, the authors concluded. Yet they also warned against an excessively rapid response.
“There should be fiscal adjustment, but it cannot be too abrupt,” they wrote. “There should be a downsizing of government, but without preventing it from playing a key role in the provision of basic services, and in particular in maintaining a level playing field by giving equal opportunities to all individuals regardless of their conditions at birth.”
The two authors continued: “The current environment of low interest rates, which has so far kept debt service payments under control in G7 economies despite surging deficits and debt levels, provides a window of opportunity to set the adjustment process in motion.”
A second IMF paper, by Jonathan D. Ostry, deputy director of research, found that countries differed in how much room they had before reaching unsustainable levels of public debt.
Countries like Australia, Denmark, South Korea, New Zealand and Norway can borrow more, while several countries in Southern Europe, along with Japan, have little space and need to adopt fiscal retrenchment that departs markedly from their historical practices, Mr. Ostry found.
A “worrisome conclusion” is that market fears about negative economic shocks could by themselves “trigger an increase in interest rates that would drive a formerly sustainable country into a situation of unsustainability,” according to Mr. Ostry and his co-authors, Atish R. Ghosh, Jun I. Kim and Mahvash S. Qureshi.
Of the three papers, the least dire concluded that defaults were “unnecessary, undesirable and unlikely.”
That paper, written by Mr. Cottarelli with Lorenzo Forni, Jan Gottschalk and Paolo Mauro, found that countries would not benefit from defaulting because structural deficits, not interest payments, were their main problem. Historically, countries have defaulted not as a strategy to get out of their debts, but while they were in the midst of a refinancing crisis, they found.