High public debt in an uncertain world: Post-Covid-19 dangers for public finance

In this EconPol Policy Brief Daniel Gros cautions countries with high debt ratios not to simply rely on low interest rates to make their (Covid-19) debt sustainable. Now that the health emergency is subsiding, governments have to chart a new course for public finance. The starting point is a higher level of public debt. However, high debt ratios represent a danger, even when interest rates are low. The key reason is increased uncertainty of growth prospects in a post-Covid-19 economy, coupled with an uncertainty regarding the probability of future large shocks. A prudent policy would therefore be to start reducing debt levels to pre-crisis levels as soon as the economy normalizes, according to the author. Key messages: High debt ratios represent a danger, even if interest rates are low. - The key reason is increased uncertainty of growth prospects in a post-Covid economy coupled with and uncertainty with regard to the probability of future large shocks. - Large negative shocks are more frequent than assumed in standard models. - Another reason is that the cost of public debt might increase more than linearly as the debt ratio rises. - Large negative shocks create much more problems when debt is already high.