The agreement between the European commission and the Italian government is a bluff

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

Three points on Italy, its budget and the European Commission

The European Commission has just told Italy to revise its 2019 budget plan: the deficit does not look excessive (2.4%), but the figure is deemed to be fragile as growth projections are overly optimistic….and with a government that emerged from a watershed vote, we should expect a certain degree of laxity on spending to boot. The government was not elected to do the same thing as its predecessors, i.e. there is a risk that the budget will spiral out of control and move above the notorious 3% of GDP threshold, which is incompatible with a stabilization in public debt. Italian public debt stands at close to 132% of GDP, well above the standard 60%, and this is not sustainable. Yet does a sustainable trend automatically involve a drastic cut in the public deficit? Maybe not.

There are a number of points worth raising on the budget/Italy/European Commission issue.  Continue reading

French public debt stands at 100% of GDP – My Tuesday column

This post is available in pdf format My Tuesday Column – 1 October 2018

French public debt stands at close to 100% of GDP, but is this really a cause for concern?
No – it is important not to overstate the importance of this figure. French statistics body INSEE made the news as it measured public debt at over 100% of GDP for 2017, when it included railway operator SNCF’s debt. However, this is no longer the case, with debt accounting for 99% of GDP in the second quarter of 2018.
The chart shows two phases in French public debt trends – before and after the 2008 financial crisis. The State increased its debt issues and thereby smoothed the way for macroeconomic adjustment to the crisis by spreading out the shock that hit the French economy over the longer term.
We can see that the figure then rises again after 2010, but this is not a specific feature to France. It reflects slower growth in the French economy over the longer term, and a welfare set-up that failed to change to adapt to this new trend: so soaring public debt denotes a sluggish adjustment from French institutions.
In other words, the primary role of public debt is to help spread the load at times of economic shocks, but it skyrockets when the economy is slow to adjust to new economic conditions.dettemaastrichtFrance-en.png

Is the 100% of GDP threshold a problem or not?
The figure itself is impressive and somewhat symbolic, but it is not necessarily damaging for economic momentum per se. Japanese public debt stands at 240% of GDP, yet the country has come through the financial crisis better than others judging by per-capita GDP: the country does not seem to be in danger of default.
The real problem is that we do not know just when public debt can actually become detrimental. Rogoff and Reinhart indicated in their research that public debt begins to dent growth when it moves beyond 90% of GDP, and this rule at least partly spurred on the European Commission’s austerity policy in 2011 and 2012. However, this argument does not hold water: R&R’s calculations were wrong and there is no rule on excessive public debt. Continue reading

Public debt – Private debt: the real heart of the matter is not where we think (Part 2)

In last week’s column (see here), I discussed the importance of public debt as an asset that enables wealth to be transferred to a date in the future, while restricting risk, along with its ability to effectively absorb economic shocks. I also noted that I was less concerned about public debt than private debt, particularly household debt.

The major difference between public debt and household debt is that a credible State issuer can issue debt with sometimes very long maturities, which households cannot do, so they do not have the same flexibility to adapt to shocks. Continue reading

Public debt – Private debt: the real heart of the matter is not where we think (Part 1)

Public debt is evil. This is the kind of statement we often see in the press, but it is wrong. If we are going to be concerned about excessive debt levels, we should worry more about the private sector’s debt: it is this private debt, and in particular household debt, that lay at the root of the 2007 crisis, and not public debt that had already been cut back before the crisis. Ten years later, private debt remains high, especially in Europe, and this restricts private sector players’ ability to adjust.

But before we look at private debt, let’s take a look at the issue of public debt, where we can make a number of observations: Continue reading