Policy Brief n.32 - The Fallacy of r – g

Executive Summary

The sustainability of public debt is an essential component of fiscal policy evaluation. The public debate has increasingly focused on the relationship between two key variables, the rate of interest paid on the debt (r) and the rate of growth of the economy (g). When growth is projected to be systematically higher than the rate of interest (r – g < 0), countries do not need to have a (high) primary budget surplus to ensure that the ratio between public debt and gross domestic product decreases over time. In other words, fiscal policy has greater room for maneuver when economic growth is higher than interest payments on the debt

The empirical evidence does not confirm the hypothesis that the public debt tends to be more stable in countries where the (real) interest rate is systematically lower than (real) growth. On the contrary.

In countries where the interest rate was lower than nominal growth, the debt often increased markedly over the past quarter century (as a percentage of GDP).

The most obvious case is the US, where the debt-to-GDP ratio doubled, from 60% to 120% of GDP, despite a negative r-g for most of the period.

In Japan and in France, debt increased irrespective of the r-g level.

Only in Germany the correlation between r-g and the debt dynamics turned out as expected, as debt decreased in parallel with lower interest rates. In Italy, the relationship changed over time.

Overall, r-g does not look like a good predictor of debt development.

IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.

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