Public debt and the world financial market

Abstract

World public debt has increased by 30% of world GDP between 2007 and 2017. During the same period, the real interest rate on public debt has fallen by roughly 200 basis points, whereas it should have increased by 100 basis points according to previous estimates. This reveals that demand for public debt has increased faster than supply. Where does the increase in savings come from? To answer this question, we construct the world financial market equilibrium to identify the country and agents across countries who increased their saving rate. Using the equality between the sum of private and public saving and investment at the world level, we observed four key phenomena. First, the world investment rate has been slightly increasing during the period, with an impressive shift of investment in China. The investment rate of China was 6% of world GDP in 2007. This jumps to 12% in 2017. Second, during the 2007-2017 period, the world experienced an impressive reduction of global imbalances. The Chinese saving rate increased less than Chinese investment, and the US saving rate increased more than US investment. Third, the increase in the world saving rate came from highly indebted countries before 2007, mostly from the US and southern Europe. The increase in the current accounts of Italy, Spain and Greece (from a negative territory) is the order of magnitude of the increase in the US current account. Fourth, there is no clear relationship between the household saving rate and national government borrowing, thus not confirming the Ricardian equivalence view. Finally, it seems that the factors generating a high net saving rate in China are temporary, whereas the deleveraging of US and southern Europe may be long-lasting. As a consequence, one can expect low interest rates for a long period of time.