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Post-crisis Fiscal Policy$
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Carlo Cottarelli, Philip Gerson, and Abdelhak Senhadji

Print publication date: 2014

Print ISBN-13: 9780262027182

Published to MIT Press Scholarship Online: September 2015

DOI: 10.7551/mitpress/9780262027182.001.0001

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The Determinants Of The Interest-Rate–Growth Differential

The Determinants Of The Interest-Rate–Growth Differential

(p.49) 3 The Determinants Of The Interest-Rate–Growth Differential
Post-crisis Fiscal Policy

Julio Escolano

The MIT Press

This chapter examines the cross-country and temporal patterns of the interest-rate growth differential (IRGD), an essential variable in the dynamics of the debt ratio; that is, the ratio of government debt to GDP. Essentially, the IRGD is the difference between the interest rate paid on government debt and the growth rate of GDP and drives the inertial or “snowball” dynamics of the debt ratio. The chapter first discusses and quantifies the IRGD-driven snowball effect on debt; this effect turns out to be large but generally of opposite sign in advanced and nonadvanced economies. In the latter, a large negative snowball effect—rooted in negative IRGDs—has allowed sustained significant primary fiscal deficits without exploding debt ratios. The chapter shows that IRGDs are associated with GDP per capita, but that the policy room provided by strongly negative IRGDs may contract over time as a consequence of financial development and globalization. It argues that negative IRGDs are not rooted in a long-term income catch-up process but in negative real interest rates brought about by financial repression that stunts economic growth.

Keywords:   interest-rate growth differential, debt ratio, government debt, snowball effect, fiscal deficits, GDP per capita, income, real interest rates, economic growth

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