debt-GDP Ratio Research Articles

Is the ‘Euro Bond’ the Answer to the Euro Sovereign Debt Crisis? What Outcome Can Investors Expect from Europe?

This article analyzes the causes of the sovereign debt crisis in the euro zone and examines the policy alternatives confronting euro area governments. The author suggests that pooling fiscal risks, creating an EU Treasury, and issuing jointly backed euro bonds would be an optimal solution and the inevitable conclusion of the economic integration project in Europe. The author examines the advantages and disadvantages of euro bonds and concludes that issuing euro bonds would transform a market that is fragmented along national lines into a single unified European government bond (EGB) market with the same depth, breadth, and liquidity as the U.S. Treasury market. By enhancing the size and liquidity of the EGB market, global investors and wealth managers would be able to use euro bond instruments as a tool for payment or transaction needs as well as short-term precautionary and investment balances, which would increase the demand for them and lower their yields. This development would allow the euro area to extract “seigniorage” benefits similar to those that the U.S. has enjoyed in the post-World War II period, which would lower funding costs even for fiscally strong euro area countries. It would also consolidate the euro as one of the world’s two principal reserve currencies. The risk that fiscally weak area countries might take advantage of low borrowing costs to increase debt could easily and effectively be mitigated by agreeing on a formula that would establish an escalating rate in the sharing of interest costs that would be proportional to their debt–GDP ratios. Thus, moral hazard would be mitigated, and incentives would be created to reduce debt and increase income. <b>TOPICS:</b>Fixed income and structured finance, developed, financial crises and financial market history

Stabilizing the Euro area and overcoming the confidence crisis

After a successful starting decade, the Euro zone is heading towards very serious problems and this is partly because of inadequate national policies of some member countries and partly due to a doubtful crisis management. As regards the former, the Greek deficit of 2009 with a deficit-GDP ratio of 15% is as crucial as the Irish deficit shock of 32% in 2011 where 2/3 was a one-off effect of the government’s recapitalization of banks which for years had acted under “light” (totally ineffective) supervision. Italy with its high debt-GDP ratio is also a problem in the context of nervous financial markets, higher risk premiums and a general increase in debt-GDP ratios in both the US and Europe in the period of 2007–2011. The crisis management of the European Council has not been effective, including the problem of haircuts for Greece in 2011, which were imposed against warning from the ECB—the risk that confidence in bonds markets would be undermined was not taken seriously. In late November 2011, the prices of credit default swaps have been rising for almost all Euro area countries and liquidity in the interbank markets had dried out in almost all Euro countries except for Germany. The Belgish-FrenchLuxumbourgian Dexia bank was the first big EU bank from those that had been rescued in the Transatlantic Banking Crisis that needed new rescue funding in late 2011. From an analytical perspective macroeconomic analysis should be refined and revised in several ways (Welfens 2011). Int Econ Econ Policy (2012) 9:7–12 DOI 10.1007/s10368-011-0204-1

Erratum to: ‘Assessing the fiscal stance in the European Union and the United States, 1970-2011’

Volume 26, Issue 68, Pages: 599–647. Article first published online: 3 OCT 2011 | DOI: 10.1111/j.1468-0327.2011.00270.x The results for Finland and France have been labelled incorrectly in a number of instances with those for France attributed to Finland and vice-versa. This has affected: 1. The debt and deficit GDP ratios reported in tables 1 and 2: the 2007, 2010 and 2011 data for France and Finland need to be switched. 2. The presentation of the results in tables 6 and 7: all the numbers are correct, but the row labelled FIN is in fact FRA and vice-versa. 3. The presentation of the results in tables 8 and 9, as the FSI results are copied from tables 6 and 7. View this table: Table 1 Government debt-GDP ratios for EU countries and the US, 1970–2011 View this table: Table 2 Primary Deficit-GDP ratio for EU countries and the US, 1970–2011 View this table: Table 6 Annual adjustment to the deficit-GDP ratio required to …

A model-based indicator of the fiscal stance

We argue that the conventional approach to assessing the fiscal stance based on econometric tests of the government present value budget constraint (PVBC) is of limited practical use. We propose an alternative measure that focuses on short-run fluctuations in the fiscal stance, namely, a model-based indicator that compares a target level of the debt-GDP ratio at a given point in the future with a forecast based on the government budget constraint (GBC) where the forecasts are obtained using a recursively estimated VAR. By log-linearising the GBC the index can be decomposed into the various different components of which it is comprised. Using data from 1970 to 2011 we conduct a detailed time-series study of the fiscal stances of four countries: the United States, the United Kingdom, Germany and Greece and we calculate the index for 11 other EU countries. For most countries the index shows that their fiscal stances vary from being too loose to too tight. Almost without exception the index drops sharply from 2007 showing the harmful effect on their fiscal stances of the recent recession.

War and peace: Explosive U.S. public debt, 1791–2009

We show, in this study, that the U.S. public debt–GDP ratio was explosive in nature during the 1791–2009 sample period. The huge increase in U.S. debt during World War II is responsible for this result. Our findings differ profoundly from those generated by the standard unit root tests, which typically conclude that the U.S. public debt had a unit root.

Assessing the fiscal stance in the European Union and the United States, 1970-2011

The huge increases in debt-GDP ratios following the 2007–2009 global financial crisis, which are unprecedented except in times of war, has focused attention on the viability of the fiscal positions of EU countries and the US, how to assess this and the likely future evolution of these positions. This paper proposes an indicator of the fiscal stance which computes the fiscal adjustment required to reach a specific debt-GDP targeted given the forecasts of future deficit and interest rates obtained from an unrestricted (recursively-estimated) VAR model. The index is easy to compute and can be decomposed to disclose the different contribution of revenue, expenditure, nominal yields, inflation and growth to the fiscal stance. For this reason it provides a transparent and detailed measure of the fiscal stance, particularly suitable for multi-country surveillance. As a result, the index improves on the tax-gap indicators widely used by governments and international agencies, and is far more informative than formal econometric tests of fiscal sustainability. The time series of the indicator for individual EU countries and the US show that their fiscal position has fluctuated considerably over the last 40 years, and has particularly deteriorated since 2007. The index predicts that the adjustment required to restore pre-crisis debt-GDP levels are higher for high debt countries like Greece, Italy and Portugal. They become more severe the shorter is the time horizon for the adjustment. As a large degree of uncertainty surrounds the assessment of the fiscal stance in the medium and long run, we argue that policy makers should inform their policy based on the worst case scenario predicted by the indicator.

Fiscal policy switching in Japan, the US, and the UK

This paper estimates fiscal policy feedback rules in Japan, the United States, and the United Kingdom for more than a century, allowing for stochastic regime changes. Estimating a Markov-switching model by the Bayesian method, we find the following: First, the Japanese data clearly reject the view that the fiscal policy regime is fixed, i.e., that the Japanese government adopted a Ricardian or a non-Ricardian regime throughout the entire period. Instead, our results indicate a stochastic switch of the debt-GDP ratio between stationary and nonstationary processes, and thus a stochastic switch between Ricardian and non-Ricardian regimes. Second, our simulation exercises using the estimated parameters and transition probabilities do not necessarily reject the possibility that the debt-GDP ratio may be nonstationary even in the long run (i.e., globally nonstationary). Third, the Japanese result is in sharp contrast with the results for the US and the UK which indicate that in these countries the government’s fiscal behavior is consistently characterized by Ricardian policy.

RULES VERSUS DISCRETION IN FISCAL POLICY*

This paper applies the Kydland–Prescott framework of dynamic inconsistency to fiscal policy by considering the trade‐off between output and debt stabilization. In a static framework, commitment to debt stabilization is superior to discretion only when the public debt–GDP ratio is high. Discretion, though, is always inferior to an optimal fiscal rule, which however entails a positive predetermined debt growth. As usual, the introduction of uncertainty determines an additional advantage for discretion. Finally, if dynamic considerations are introduced, the optimal fiscal rule is characterized by positive debt growth in the short run and debt stabilization in the long run.

From the transatlantic banking crisis to the euro crisis?

The Transatlantic Banking Crisis has strongly raised debt-GDP ratios in many OECD countries and this is undermining the economic recovery. As regards the euro zone there are special problems which are partly related to lack of fiscal discipline in Greece and to the Irish economic crisis which—largely unknown—basically reflects total failure of prudential supervision to apply EU directives and legislation, respectively. In this context the issue is raised whether or not there are structural problems with the Euro and monetary integration. Moreover, the debt dynamics of governments are analyzed and specifically the issue of whether there is a need for restructuring the debt of Greece. Taking a closer look at the figures for government assets in Greece, it seems possible to strongly reduce the debt-GDP ratio mainly by privatization. As regards Ireland, one may propose that the European Commission or the European Parliament take the country before the European Court of Justice. Finally, a new approach for determining the optimum debt-GDP ratio is presented.

External Sovereign Debt in a Monetary Union: Bailouts and the Role of Corruption

We build a tractable stylized model of external sovereign debt and endogenous international interest rates. In corrupt economies with rent-seeking groups stealing public resources, a politico-economic equilibrium is characterized by permanent fiscal impatience which leads to excessive issuing of sovereign bonds. External creditors envision the corrupt economy’s fiscal impatience and buy its bonds at higher interest rates. In turn, this interest-rate increase exacerbates the problem of oversupplying debt, leading the economy to a perfect-foresight trap. In incorrupt countries which have entered a high-interest-rate/high debt-GDP-ratio trap because an immediately recent disaster has caused a sudden jump to a high outstanding debt-GDP ratio, we show that bailout plans with controlled interest rates can help in reducing debt-GDP ratios after some time. On the contrary, under corruption, we show that bailouts are ineffective unless rent-seeking groups are eradicated.

Oil Prices and Economic Activity in Pakistan

Oil price shocks have raised serious concerns among the policy makers around the world because of its adverse impacts for the net oil-importing economies. This article, based on the data from 1979–80 Q1 to 2007–08 Q2, analyzes the impact of rising oil prices along with the changing macro conditions on output. Oil prices and output are found to be strongly related, and to a great extent this relationship is non-linear. In addition, lower debt-GDP ratio, lower deficit spending, lower real effective exchange rate, and the existence of foreign exchange reserves and capital investment would cause output to rise. In Pakistan, besides making adjustments at the macro level, what is required is to make rational choices about the development of energy mix for the future to reduce the risk of oil price fluctuations in the global energy market.

Interest Rate Risk and Other Determinants of Post-WWII US Government Debt/GDP Dynamics

This paper uses a sequence of government budget constraints to motivate estimates of returns on the US Federal government debt. Our estimates differ conceptually and quantitatively from the interest payments reported by the US government. We use our estimates to account for contributions to the evolution of the debt-GDP ratio made by inflation, growth, and nominal returns paid on debts of different maturities. (JEL E23, E31, E43, G12, H63)

Primary balance, public debt and fiscal variables in postsocialist members of the european union

The primary balance has influenced the unit costs of debt servicing in 10 postsocialist members of the EU. The effects of the GDP growth and the inflation are equally robust and significant. The coefficients of lagged debt are at variance with the expectations from Bohn's 1998 paper, and one cannot speak until now about the corrective actions of fiscal authorities in these countries. Only Poland has had on average a higher real long-term interest rate than the growth rate. Other countries could stabilize their debt-GDP ratio by running a primary deficit. But comparing the level of investment with profits only in Slovenia one can speak about the dynamic inefficiency. Especially in the Czech Republic and Slovakia the relationship between debt and deficit is blurred by high negative stock-flow adjustments.

Monetary and Fiscal Rules in an Emerging Small Open Economy

We develop a optimal rules-based interpretation of the 'three pillars macroeconomic policy framework': a combination of a freely floating exchange rate, an explicit target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies. The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions It is calibrated using Chile and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules alongside a 'Structural Surplus Fiscal Rule' as followed recently in Chile. A comparison with a fixed exchange rate regime is made. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy.

Monetary and Fiscal Rules in an Emerging Small Open Economy

We develop a optimal rules-based interpretation of the 'three pillars macroeconomic policy framework': a combination of a freely floating exchange rate, an explicit target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies. The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions It is calibrated using Chile and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules alongside a 'Structural Surplus Fiscal Rule' as followed recently in Chile. A comparison with a fixed exchange rate regime is made. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy.

Política fiscal, sustentabilidade da dívida pública e liquidez dos títulos: uma análise para o Brasil

Este artigo trata do esforço fiscal adotado desde 1999 no Brasil, e da importância de um mercado de títulos públicos de liquidez elevada para que o esforço fiscal seja aliviado. É aplicado um modelo baseado em Edwards (2003) para projetar o resultado fiscal primário, levando em consideração diferentes cenários de demanda por títulos, taxa de crescimento real do PIB, meta de inflação, remuneração dos títulos públicos e choques na taxa de câmbio. Com isso, avaliou-se o impacto de alterações na procura pelos títulos públicos sobre o esforço fiscal necessário para estabilizar a proporção dívida/PIB. Os resultados indicam que as alterações na demanda por títulos alteram a sensibilidade do esforço fiscal a alterações na taxa de crescimento do PIB e a mudanças na taxa de câmbio, enquanto as demais variáveis influenciam o esforço fiscal com sensibilidade constante.

UK DEBT SUSTAINABILITY: SOME NONLINEAR EVIDENCE AND THEORETICAL IMPLICATIONS*

In this paper we assess whether the UK public finances were sustainable for the period 1919–2001. A robust test of sustainability is presented using a nonlinear representation of the debt–GDP ratio. Empirical evidence supports debt sustainability. Moreover, the exponential smooth transition autoregressive representation is evidence that sustainability is the result of active debt management rather than tax smoothing. The results strongly support the active debt management hypothesis for the UK.

Probabilistic Sustainability of Public Debt: A Vector Autoregression Approach for Brazil, Mexico, and Turkey

This paper examines the sustainability of fiscal policy under uncertainty in three emerging market countries—Brazil, Mexico, and Turkey. For each country, we estimate a vector autoregression that includes fiscal and macroeconomic variables. Retrospectively, a historical decomposition shows by how much debt accumulation reflects unsustainable policy, adverse shocks, or both. Prospectively, Monte Carlo techniques reveal the primary surplus required to keep the debt-GDP ratio from rising in all but the worst 50, 25, and 10 percent of circumstances. Such a value-at-risk approach presents a clearer menu of policy options than do frameworks currently in use.

Government deficits, wealth effects and the price level in an optimizing euro-model

In the context of the current policy debate on the reform of European fiscal rules, there is wide consensus on the need to place more attention on debt–GDP ratios. Proposals have been made to alleviate fiscal pressure on Member States with relatively low public debts. The present paper gives support to this view. Economies with high public debt–GDP ratios are shown to experience larger price deviations after a fiscal expansion. These results are derived in a model, calibrated to euro area quarterly data, with capital accumulation, flexible prices and wealth effects in the presence of an independent monetary authority.

Is the Quantity of Government Debt a Constraint for Monetary Policy?

This paper derives an interest rate rule for monetary policy in which the interest rate response of the central bank toward an increase in expected inflation falls as debts increase beyond a certain threshold level. A debt-constrained interest rate rule and the threshold level of debt are jointly estimated for Canada during the first decade of its inflation targeting regime of the 1990s. There are three main findings of this paper. First, a high government debt could constrain monetary policy if government spending-rather than taxes-is expected to adjust in future in line with debt service costs. The 'constraint' operates through an altered policy transmission mechanism through changes in the IS curve. Second, the effects of the debt-constraint on monetary policy are quite different during booms and recessions. Third, empirical estimates show that Canadian monetary policy might have been constrained by a high government debt-GDP ratio during the 1990s. Policy was less loose than what inflation indicators called for.