How to make George Osborne happy: The IMF thinks the UK could live with higher debt “forever”

Could this be the economic argument George Osborne has been waiting for?  Our obsession with clearing the UK's debt could be more trouble than it's worth, according to a new paper published by the IMF. 

 

Although high levels of debt are generally viewed as problematic, advanced economies such as the UK's could “simply live with higher debt forever”. 

 

This is because when the government pays down $1 of public debt it incurs the “distortionary costs of raising another dollar of revenue”.

 

“If it defers repayment to tomorrow, the debt will have grown by the market interest rate, (1+r), and the cost will be the distortion associated raising an additional $(1+r). But the government discounts the future at precisely the market interest rate, so it gains nothing by paying down a dollar of debt today,” the IMF explains.

 

“Since the same argument can be applied to any period, the government will just live with the original inherited debt.” 

 

The paper warns that this is not the case with all economies – there are several that are too vulnerable to take on the associated risks of running on fumes – and also acknowledges that there are potential negative consequences to adopting this strategy, but on balance it makes sense. 

 

 

"Where countries retain ample fiscal space, governments should not pursue policies aimed at paying down the debt, instead allowing the debt ratio to decline through

growth and “opportunistic” revenues, living with the debt otherwise," the paper says. 

 

Economies including Norway, South Korea and Germany are in the clear zone, with the UK just clearing the barrier ahead of France, Belgium and Spain.

 

Cyprus, Greece, Italy and Japan shouldn't even think about it.