Also the financial markets’ reaction to any given level of public debt is powerfully influenced by their expectations on future fiscal behaviour. Accompanying the fiscal stimulus with credible action to right the public finances in the medium term can limit the rise in interest rates stemming from a temporary upsurge in debt.
This strategy is particularly important for countries with high debt or a weak reputation for fiscal rectitude. The problem, particularly at the present juncture, is how to make this commitment to medium-term consolidation credible while preserving the necessary flexibility in the short term.