Despite the agreement between the Italian government and the European Commission, the question of the Italian public debt sustainability is not solved. The marginal move from the government (reducing its budget deficit to 2.04% of GDP vs an initial 2.4%) is not sufficient to explain it.
The best explanation is that no one wanted to have the responsibility of a deep European financial crisis linked to the lack of liquidity of the Italian debt market The commission has accepted because the situation was not manageable.
In the short term, investors will be pleased and the spread with the German Bund will narrow. But the main question is not solved. Growth in Italy is too low.
The Italian economy is already in recession (GDP growth was negative in Q3 and companies’ surveys are on the contracting side of the economic activity) this means that the budget deficit will converge to 3%, not 2%
The question on the debt is that interest rates are higher than the GDP nominal growth. Therefore the public debt to GDP has a growing bias(a snowball effect). Italy has had a primary budget surplus for years, it is not the question. For Italy a sustainable path for its public debt must find a way to make the government credible in order to limit the premium on its interest rate and to find a way to boost its growth. Who can imagine that? Be prepared then for the next financial crisis it is coming
Here is the frightening part of the Italian budget: growth figures. In an interview Giovanni Tria said that growth forecasts for 2019 and 2020 were 1.6% and 1.7% respectively.
These are unbelievable expectations. Such numbers were attained only in period of global euphoria (2006) or of global recovery (2010). This will not be the case in 2019 or 2020. The Italian GDP growth trend is just 1.1%. That’s why budget numbers are at risks.
We cannot bet on a 2.4% budget deficit in 2019, 2020 and 2021. We must have lower growth figures in mind and probably higher expenditures. The situation is at risk in Italy In other words, the reduction of the public debt (reduction of the public debt to GDP ratio by 1% every year ) will not be achieved.
The Italian budget program, which sets out a budget deficit of 2.4% of GDP for 2019, 2020 and 2021, did not go down very well with investors. Uncertainty on Italy is making a comeback and the yield on the 10-year government bond rose sharply as shown by the chart below (as at 15.00pm CET today).
So just what are investors worried about? Continue reading
When our grandchildren study economics one day, will they systematically have to add a dummy variable* to their econometric equations for the period covering the Trump administration? Will the US economy over this period have something of a “special status” due to Trump’s and Congress’ decisions? This question is worth raising in light of moves to cut taxes and raise spending, with the ensuing effects on the appalling US public deficit.
The state of public finances is the trickiest of questions. The sustainable rise in the public deficit seems to show that the economy is undergoing a severe recession, yet this is far from true as Janet Yellen took the economy to full employment (see analysis from Jason Furman). So economic stimulus moves from the White House and Congress raise very real questions on the rationale behind this policy. Governments do not embark on economic stimulus programs when the country is running on full employment, otherwise major long term imbalances are created, which are bad news for all concerned. Continue reading
Is the French economy becoming virtuous? With the public deficit falling below the 3% mark, it is tempting to think so… 2.6% for the full year 2017 and 2.1% for the last quarter of the year, so it is really very tempting.
But yet if we look at the figures and the consistency of public accounts with the acceleration in growth in 2017, our bubble bursts as the public deficit profile perfectly follows the trend in growth, which virtually doubled between 2016 and 2017, surging from 1.1% to 2%, so public finances naturally improved. We can see on the chart the strong consistency between the public deficit profile and the pace of real growth with a two-quarter lead. The deficit improves alongside economic growth but it is still difficult to stay on course when growth slows.