IMF Working Paper

The Great Recession of 2007-09 has led to a significant increase in public debt, in large part due to the collapse in tax revenues as incomes fell. Other contributors to the debt build-up were the costs of financial bailouts of banks and companies, and the fiscal stimulus provided by many countries to stave off a Great Depression. As a consequence, in advanced economies public debt has increased on average from 70 percent of GDP in 2007 to about 100 percent of GDP in 2011—its highest level in 50 years (IMF Fiscal Monitor, 2012). In the absence of significant consolidation measures, debt-to-GDP ratios in many advanced economies are likely to remain high over the medium term.

Against this backdrop, many governments have been undertaking policies to reduce debt through a combination of spending and tax-based consolidation measures (IMF 2012). When British Prime Minister David Cameron announced his government’s deficit reduction plans he said “Those who argue that dealing with our deficit and promoting growth are somehow alternatives are wrong. You cannot put off the first in order to promote the second.” The challenge facing the United Kingdom and many advanced  economies is how to bring debt down to safer levels in the face of a weak recovery. Will deficit reduction lead to stronger growth and job creation in the short run? What will be the distributional consequences?