Turning lemons into lemonade: government debt and maturity during the Great Recession

02 settembre 2016

anne.bernier@prometeia.com, lorena.vincenzi@prometeia.com

The Global Financial Crisis demanded strong policy responses, government intervention in the real and financial sectors, and stimulus spending. Looking back eight years later, these actions were expensive and increased government debt around the globe. However, as interest rates fell to record lows, many governments seized the opportunity to borrow long-term.

 

The Great Recession and the accompanying countercyclical spending are the major sources of increased public debt as a percentage of GDP in many industrialized countries from 2007 to 2015 (Fig. 1). In the United States and the United Kingdom, increased public spending alleviated private sector debt, with a net effect of a lower gross debt in 2015 than 2007. Japan has the highest government debt (212% of GDP in 2015), as well as the highest overall debt at 528% of GDP. However, Japanese public debt is considered safe, as it mainly takes the form of bonds held by Japanese citizens and institutions. Interest paid on Japan’s internal debt flows back to the government in the form of taxes, and domestic banks are likely to roll over their own government debt. 

 
Figure 1 - Gross debt by sector (% of GDP)
Source: BIS, Eurostat, national central banks
 

In most cases, these increases in public debt were deliberate. The governments of UK, US, and Spain bailed out British, American, and Spanish financial institutions during the crisis from 2008 onwards. Some governments also rescued non-financial corporations. For example, the United States bailed out General Motors and Chrysler and France intervened in the case of Renault and PSA Peugeot Citroën. Other governments chose to focus their intervention on the demand side, such as programs to encourage new car purchases in Italy, Germany, South Korea, Japan, and, again, the US. These interventions increased government spending while helping decrease non-financial corporations’ debt. Government spending also increased through infrastructure investments, employment programs and tax rebates to households and corporations. 

Along with these expansionary fiscal policy responses to the crisis, monetary policy created an environment of low interest rates to stimulate investment and spending, which raised the opportunity to compress government debt costs. If interest rates slowly rise, but a large portion of the debt dates to the period of low interest rates and has a long maturity, the average interest rate the government must pay rises more slowly than market interest rates or inflation, making it easier to pay off the debt the governments accrued. 

 
Figure 2 - Average maturity of public sector debt (years)
Source: OECD
 

Most of the countries considered have increased the average maturity of their public debt during the period of low interest rates following the crisis (Fig. 2). The average maturity of British debt, 16.2 years, is almost twice as long as the second longest maturity, Japan, 9 years, whereas South Korea increased its maturity the most since the crisis, by 3.3 years. 

For some countries, average maturity did not change much, like in Italy, where it returned to its 2004 level after peaking in 2010, and Spain, where it returned to its 2005 level after peaking in 2007. Maturity remained roughly constant in France. Nevertheless, maturity remained high in these countries. Fluctuations in maturity could be due to several factors, such as market preferences for more liquid assets in the form of short-term debt. 

All in all, industrialized countries seized the opportunity presented by the 2008 crisis to borrow long-term at low rates and increased the average maturity of their public debt. Longer maturity contributes to the debt’s sustainability, as it eases the debt burden and helps shelter governments from rising interest rates when monetary policy tightens. Alternatively, if rates stay low but inflation increases, the cost of payments on long-term public debt will probably be lower than on any new debt, and the debt burden will naturally ease.

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