09/10/18   1   Economic  Policy  #04   Fiscal  Policy  2   Public  debt   Public  debt  =  the  total  of  all  bonds  and  other  debt  owed  by   a  government.  Usually  cumulated  deficits.     Debt-­‐to-­‐GDP  ra,o  =>  ability  to  repay  the  debt.  But  the   public  debt  needs  not  be  repaid.     Net  public  debt  =  gross  public  debt  –  value  of  public  assets     Problem  of  off-­‐balance-­‐sheet  liabili/es  (ageing,  too-­‐big-­‐to   fail  banks)     EP#04:  Fiscal  Policy   Gross  vs.  net  debt  Gross vs net debt Gross and net public debt ratios in selected OECD countries in 2010 (% of GDP) 13 Bénassy-Quéré, Economic Policy, 2011-12 Source : OECD EO90, December 2011. Source:  Bénassy-­‐Quéré  (2012)  EP#04:  Fiscal  Policy   09/10/18   2   Large  deficits  were  mostly  the  results   of  wars  (e.g.  USA)   Large deficits are mostly the results of wars (and crises) The US example 21 Source: Bianco Research Source:  Bénassy-­‐Quéré  (2012)   EP#04:  Fiscal  Policy   Public  debt  raUos  have  reached  very   high  levels  in  the  past   Fig.  Gross  debt  (as  %  of  GDP)   Public debt ratios have reached very high levels in the past Gross debt (% of GDP) 24 Source: Masson and Mussa (1995) and OECD (Economic Outlook 84, November 2008, and March 2009 Interim Economic Outlook). Data for France are 5-year averages until 1960 Bénassy-Quéré, Economic Policy, 2012-13 Source:  Bénassy-­‐Quéré  (2012)  EP#04:  Fiscal  Policy   Advanced  countries  have  been  in   deficit  since  1970   Fig.  Public  expenditure  and  receipts  in  OECD  countries   Advanced countries have been in deficit since 1970 Public expenditure and receipts in the OECD countries 22Source: OECD. Bénassy-Quéré, Economic Policy, 2012-13 Source:  Bénassy-­‐Quéré  (2012)  EP#04:  Fiscal  Policy   09/10/18   3   Debt  sustainability   •  Solvency:  borrower’s  ability  to  face  its  commitments     •  Sustainability:  policy  course  compaUble  with  solvency  at   all  Umes  in  the  future     •  Sustainability  is  forward-­‐looking  by  nature  and  relies  on   assumpUons  on  future  policy  and  on  the  ability  of  the   government  to  collect/increase  taxes.       EP#04:  Fiscal  Policy   Debt  and  deficit  dynamics   •  Stock-­‐flow  equaUon:  B  =  (1+i)  B-­‐1  +  D  where  D  is  the   primary  deficit,  B  is  the  public  debt  and  i  is  the  nominal   interest  rate.     •  In  percentage  of  nominal  GDP:     •  DenoUng  by  n  nominal  GDP  growth,  g  real  GDP  growth   and  r  the  real  interest  rate:     • Stock-flow equation: B = (1+i) B-1 + D where D is the primary deficit, B is the public debt and i is the nominal interest rate. • In percentage of nominal GDP: • Denoting by n nominal GDP growth, g real GDP growth and r the Debt and deficit dynamics GDP D GDP GDP GDP B i GDP B +×+= − − − 1 1 1 )1( • Denoting by n nominal GDP growth, g real GDP growth and r the real interest rate: • Implications: • Maastricht criteria: d + ib = 3% ; π + g = 5% ; b = 60% • The debt ratio can remain constant despite permanent deficits (ex. b = 80%, g = 2%, π=2%, d+ib=3.2%) • If r > g, debt stabilization requires a primary surplus 16 dbgrdbnidb n i b +−+≅+−+≅+ + + = −−− 111 )1()1( )1( )1( Bénassy-Quéré, Economic Policy, 2012-13 • Stock-flow equation: B = (1+i) B-1 + D where D is the primary deficit, B is the public debt and i is the nominal interest rate. • In percentage of nominal GDP: • Denoting by n nominal GDP growth, g real GDP growth and r the Debt and deficit dynamics GDP D GDP GDP GDP B i GDP B +×+= − − − 1 1 1 )1( • Denoting by n nominal GDP growth, g real GDP growth and r the real interest rate: • Implications: • Maastricht criteria: d + ib = 3% ; π + g = 5% ; b = 60% • The debt ratio can remain constant despite permanent deficits (ex. b = 80%, g = 2%, π=2%, d+ib=3.2%) • If r > g, debt stabilization requires a primary surplus 16 dbgrdbnidb n i b +−+≅+−+≅+ + + = −−− 111 )1()1( )1( )1( Bénassy-Quéré, Economic Policy, 2012-13 EP#04:  Fiscal  Policy   =>  if  r  >  g,  debt  stabilizaUon  requires  a  primary  surplus     Public  debt  developments  in  selected   European  countries   EP#04:  Fiscal  Policy   09/10/18   4   Net  government  indebtedness  and  primary   budget  balances,  2010  (%  of  GDP)   Net  debt  in   2010   Primary   budget  surplus   in  2010   Required  primary  surplus   to  stabilize  the   absolute  debt   stock   to  stabilize  the   debt/GDP  raUo   Belgium   80.8   -­‐0.9   4.0   2.0   Germany   50.1   -­‐1.3   2.5   1.3   Ireland   59.9   -­‐30.0   3.0   1.5   Italy   99.1   -­‐0.3   5.0   2.5   Netherlands   34.6   -­‐4.1   1.7   0.9   Source:  Burda&Wyplosz,  2013   EP#04:  Fiscal  Policy   How  to  reduce  the  debt  burden?   #1.  Fiscal  adjustment:  cut  spending,  raise  taxes   –  the  most  virtuous  but  also  most  difficult  way     As  difficult  as  it  is,  deficit  reducUon  had  been  successfully   implemented  in  many  European  countries.   1981-­‐85   1986-­‐90   1991-­‐95   1996-­‐2000   2001-­‐05   2006-­‐10   Greece   0.2   1.3   1.3   3.5   4.0   0.8   Italy   1.7   3.1   1.3   1.9   0.9   -­‐0.3   Portugal   1.5   6.2   1.9   4.2   0.8   0.5   Spain   1.3   4.7   1.7   4.1   3.3   0.9   Euro  Area   n.a.   n.a.   1.4   2.7   1.5   0.8   EU   1.5   3.1   1.5   2.9   2.0   1.0   Source:  Burda&Wyplosz  (2013)   EP#04:  Fiscal  Policy   How  to  reduce  the  debt  burden?   #2.  Raising  economic  growth   –  is  possible  in  medium  to  long  run   –  factors  determining  the  ajainable  rate  of  growth  will   be  spelled  out  later  (Growth  policy)   EP#04:  Fiscal  Policy   09/10/18   5   How  to  reduce  the  debt  burden?   #3  Mone,za,on  (infla,on  tax)   –  reducing  the  value  of  the  money  base  (the  central   bank’s  liability)  and  of  the  public  debt  (the  Treasury’s   liability)  =>  tax  on  money  and  bondholders.   –  inflaUon  must  rise  unexpectedly  and  quickly  enough     –  temporary  soluUon:  lenders  will  demand  higher   interest  rates  and  will  be  less  willing  to  agree  to  long-­‐ term  loans   –  risk  of  hyperinflaUon  if  the  government  will  be  forced   to  create  more  money  to  pay  back  maturing  debt   EP#04:  Fiscal  Policy   How  to  reduce  the  debt  burden?   #4.  Default     –  not  rare  in  Europe  before  20th  century   –  restructuring:  rescheduling,  write-­‐downs,  haircuts,   debt  conversions  (Brady  plan,  1989),  interest   reducUons...     –  voluntary/compulsory     –  coordinaUon:  Paris  club  (public  creditors);  London   club  (private  creditors);  IMF,  World  Bank.     EP#04:  Fiscal  Policy   PoliUcal  theory  of  debt   •  The  choice  of  who  should  pay  for  the  reducUon  of  a  high   debt  is  a  problem  of  redistribuUon.   •  Suppose  that  society  can  be  divided  into  three  groups:   renUers,  entrepreneurs  and  workers.   •  Each  of  these  interest  groups  will  seek  to  avoid  the   burden  of  adjustment  and  shio  onto  someone  else.   –  renUers  are  opposed  to  default  and  inflaUon  tax   –  entrepreneurs  are  opposed  to  taxes  on  capital   –  workers  prefer  taxes  on  wealth  and  capital  and  the   repudaUon  of  debt   EP#04:  Fiscal  Policy   09/10/18   6   Rules  and  principles   •  Fiscal  policy  is  tradiUonally  discreUonary   •  However  increasing  reliance  on  rules  to:     –  improve  predictability   –  address  poliUcal  failures   –  improve  credibility   –  enforce  coordinaUon   •  European  Stability  and  Growth  Pact  (1997)   •  Current  discussions  in  Europe:   –  strengthening  fiscal  discipline   –  naUonal  fiscal  rules  and  insUtuUons   EP#04:  Fiscal  Policy   More  and  more  rules   Fig.  Fiscal  rules  in  EU  member  states,  by  sub-­‐sector   More and more rules Fiscal rules in EU member States, by sub-sector 43 Source: European Commission, « Public finances in EMU 2009 ». Bénassy-Quéré, Economic Policy, 2012-13 Source:  Bénassy-­‐Quéré  (2012)  EP#04:  Fiscal  Policy   What  is  a  good  rule?   The  ‘good  rule’  according  to  Kopits  and  Symansky  (1998):   •  clear  defini/on,   •  transparent  public  accounts,   •  simplicity,   •  flexibility  –  in  par/cular  regarding  the  capacity  to  react  to   exogenous  shocks,   •  policy  relevance  in  view  of  the  objec/ves  pursued,   •  capacity  of  implementa/on  with  possibility  of  sanc/oning  non-­‐ observance,   •  consistency  with  the  other  objec/ves  and  rules  of  public  policies,   •  accompanied  by  other  effec/ve  policies   EP#04:  Fiscal  Policy   09/10/18   7   Many  rules  in  pracUce   •  Headline  deficit  rules  (SGP)   •  Structural  deficit  rules  (Germany  aoer  reform   •  Golden  rule  (Germany  before  reform,  UK  1998)   •  Debt  rules  (UK  under  Blair/Brown)   •  Spending  /receipts  rules       =>  Enforcement  is  very  uneven  and  difficult  to  check   EP#04:  Fiscal  Policy   Example  #1.  The  UK    1998-­‐2008   •  Golden  rule  (no  borrowing  for  current  spending)   •  Sustainable  investment  rule  (debt  raUo  40%  over  the   cycle)   Two  problems:   •  Who  determines  what  is  the  cycle?   •  How  to  take  conUngent  liabiliUes  into  account?   EP#04:  Fiscal  Policy   Example  #1.  The  UK  (cont.)   2010   •  Fiscal  mandate:  structural  deficit  <  1  %  of  GDP   over  5  years   •  Office  for  budget  responsibility:  independent   fiscal  council  in  charge  of  forecasts  and   assessment   EP#04:  Fiscal  Policy   09/10/18   8   Example  #2.  Germany   Since  late  1960s   •  Golden  rule  of  public  finances  ‘except  macroeconomic   disturbance’   Two  problems:   •  extensive  noUon  of  ‘macroeconomic  disturbance’   •  no  correcUon  mechanism   •  inconsistency  with  SGP  (that  does  not  disUnguish   between  current  and  investment  spending)   EP#04:  Fiscal  Policy   Example  #2.  Germany  (cont.)   2009  -­‐    (Debt  brake)   •  Fiscal  rule:  structural  deficit  <  0.35  %  (Federal   government)  and  <  0  %  (länder)   •  Control  account:  deficit  <  1  %  at  any  Ume.   •  Excep/onal  circumstances   –  natural  disaster:  more  deficit  allowed  but   amorUzaUon  plan   •  Progressive  phase-­‐in  (2016)   EP#04:  Fiscal  Policy   The  Stability  and  Growth  Pact  #1   •  Two  planks   –  PrevenUve  arm   •  Medium  term  objecUve  (MTO)   •  ‘Stability’  (Eurozone)  and  ‘convergence’  (non-­‐Eurozone)   programs   –  Dissuasive  arm  (‘Excessive  Deficit  Procedure’  –  EDP)  allows   for:   •  Advance  warning   •  RecommendaUon  to  correct  excessive  deficit  within   given  Umeframe   •  Eventual  sancUons   EP#04:  Fiscal  Policy   09/10/18   9   The  Stability  and  Growth  Pact  #2   •  Recent  reforms  (six-­‐pack,  fiscal  compact)   –  Earlier  sancUons   –  Reverse-­‐majority  voUng   –  Debt  rule   –  Broadened  surveillance  (scoreboard)   –  NaUonal  rules   EP#04:  Fiscal  Policy   Reference  textbook   Bénassy-­‐Quéré,  A.  et  al.  Economic  Policy  :   Theory  and  prac/se.  Oxford  University  Press,   2010.  Chap.  3   EP#04:  Fiscal  Policy