Benefits and Costs of Debt: The Dose Makes the Poison

Working Paper: CEPR ID: DP14439

Authors: Ayhan Kose; Franziska Ohsorge; Naotaka Sugawara

Abstract: Government debt has risen substantially in emerging market and developing economies (EMDEs) since the global financial crisis. The current environment of low global interest rates and weak growth may appear to mitigate concerns about elevated debt levels. Considering currently subdued investment, additional government borrowing might also appear to be an attractive option for financing growth-enhancing initiatives such as investment in human and physical capital. However, history suggests caution. Despite low interest rates, debt was on a rising trajectory in half of EMDEs in 2018. In addition, the cost of rolling over debt can increase sharply during periods of financial stress and result in financial crises; elevated debt levels can limit the ability of governments to provide fiscal stimulus during downturns; and high debt can weigh on investment and long-term growth. Hence, EMDEs need to strike a careful balance between taking advantage of low interest rates and avoiding the potentially adverse consequences of excessive debt accumulation.

Keywords: debt sustainability; fiscal balance; government debt; optimal debt level; private debt

JEL Codes: E62; H62; H63

Causal Claims

Cause	Effect
Debt accumulation (H63)	benefits (J32)
Debt accumulation (H63)	long-term growth (D25)
Debt accumulation (H63)	effectiveness contingent on cyclical position of the economy (E32)
Debt accumulation (H63)	effectiveness contingent on financial market development (O16)
Costs of debt (G32)	interest payments (E43)
High levels of debt (F34)	limit government's ability to enact fiscal stimulus (E62)
Debt sustainability (F34)	deteriorated in EMDEs (O54)
High debt levels (F34)	increased risk premiums (G19)
High debt levels (F34)	borrowing costs (H74)
Debt accumulation (H63)	economic stability (E63)