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An examination of alternative Strategies for Reducing Public Debt in the Presence of Uncertainty

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  • Doug Hostland
  • Chris Matier

Abstract

The Debt Repayment Plan introduced in the 1998 federal budget aims to keep the federal debt-to-GDP ratio on a "clear, downward profile". This paper examines alternative strategies for implementing such an objective. The analysis is undertaken within a stochastic simulation framework. The fiscal authority seeks to keep the debt-to-GDP ratio within a range that declines gradually over time in the presence of uncertainty about future economic and fiscal developments. We find that a medium-term fiscal planning strategy that focuses exclusively on the budget balance would require a fairly wide target range. Our estimates indicate that the debt-to-GDP ratio would have a 90 per cent confidence interval in the range of about 7 to 12 percentage points at the ten-year planning horizon. In contrast, a strategy that aims to return the debt-to-GDP ratio to its desired level in each coming fiscal year would provide a tight degree of debt control. However, such a strategy would require large and frequent discretionary changes to program spending and/or taxes and result in a pro-cyclical fiscal policy stance. As a compromise, we consider a medium-term planning strategy that aims to return the debt-to-GDP ratio to its desired level in a gradual manner. Our simulation results indicate that such a strategy could provide a moderate amount of debt control without a pro-cyclical policy stance or excessive discretionary changes. While considerably more work would be required to make it operational, this general strategy would provide the fiscal authority with the ability to trade-off its conflicting policy objectives. Le Plan de remboursement de la dette instauré dans le budget fédéral de 1998 vise à maintenir le ratio de la dette fédérale au PIB sur une trajectoire descendante. Ce document examine diverses stratégies qui pourraient permettre d’atteindre un tel objectif. L’analyse est réalisée à l’intérieur d’un cadre de simulation stochastique. Les autorités financières visent à maintenir le ratio de la dette au PIB à l’intérieur d’une fourchette qui diminue graduellement en présence d’une incertitude au sujet de l’évolution de la conjoncture économique et financière. Nous constatons qu’une stratégie de planification financière à moyen terme, portant exclusivement sur le solde budgétaire, exigerait l’établissement d’une fourchette cible assez large. Selon nos estimations, le ratio de la dette au PIB aurait un intervalle de confiance de 90 p. 100 dans la fourchette se situant entre 7 à 12 points de pourcentage environ sur l’horizon de planification de dix ans. Par contre, une stratégie visant à ramener le ratio de la dette au PIB à son niveau souhaité au cours de chacun des exercices suivants permettrait un contrôle rigoureux de la dette. Toutefois, une telle stratégie nécessiterait des changements discrétionnaires importants et fréquents des dépenses de programmes ou des impôts et elle entraînerait une orientation procyclique de la politique fiscale. Comme compromis, nous envisageons une stratégie de planification à moyen terme visant à ramener graduellement le ratio de la dette au PIB à son niveau souhaité. Les résultats de notre simulation indiquent qu’une telle stratégie pourrait permettre un contrôle modéré de la dette sans orientation procyclique de la politique ou sans changements discrétionnaires trop importants. Même s’il reste encore beaucoup à faire pour que cette stratégie générale soit opérationnelle, elle assurerait aux autorités financières la possibilité de faire des arbitrages entre leurs divers objectifs stratégiques.

Suggested Citation

  • Doug Hostland & Chris Matier, "undated". "An examination of alternative Strategies for Reducing Public Debt in the Presence of Uncertainty," Working Papers-Department of Finance Canada 2001-12, Department of Finance Canada.
  • Handle: RePEc:fca:wpfnca:2001-12
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    Cited by:

    1. Philippe D Karam & Douglas Hostland, 2005. "Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods," IMF Working Papers 05/226, International Monetary Fund.
    2. Doug Hostland, "undated". "Fiscal Planning in an Era of Economic Stability," Working Papers-Department of Finance Canada 2003-10, Department of Finance Canada.
    3. David Jamieson Bolder, 2003. "A Stochastic Simulation Framework for the Government of Canada's Debt Strategy," Staff Working Papers 03-10, Bank of Canada.
    4. Matteo Luciani, 2004. "A VAR Model for the Analysis of the Effects of Monetary Policy in the Euro Area," Rivista di Politica Economica, SIPI Spa, vol. 94(6), pages 175-214, November-.

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