High Government Debt Research Articles

Bank Lending Decision under Uncertainty: The Case of Borrowers From European Peripheral Countries in the Sovereign Debt Crisis

The European Sovereign Debt Crisis (ESDC) spanning from 2010 to 2012 results in the biggest recession since the Global financial crisis. European countries faced high government debt, rapidly rising yield spreads in government bond, and then the collapse of several European banks. The peripheral countries, Portugal, Ireland, Italy, Greece, and Spain are arguably the most unstable hosting a vast majority of financially troubled borrowers. This paper studies the implications of spillovers from affected local banking systems to other countries which have operations in these troubled economies. Using a comprehensive interbank and international syndicated loan data sample, we find evidence on how changes in the world financial market, in particular the banking industry, alter the lending decisions of local banks. We show that bank tend to tighten their loan terms significantly during the crisis period when the perception of systematic risk changes abruptly. The tightening is also observed to be much stronger for borrowers from European peripheral countries

Euro Area Membership and the Probability of a Sudden Stop: An Empirical Assessment

AbstractUsing quarterly data from 1995 until 2014, we investigate whether Euro Area (EA) membership influences the probability of a European Union Member State going through an episode of sudden stop or through an episode of bonanza, after controlling for a number of push and pull factors. Overall, our results do not support the claim that EA membership constituted a weakness during the recent financial crisis. On the contrary, we find that EA membership decreases the probability of a sudden stop, all else equal. We find no evidence that being part of the EA has a direct effect on the probability of bonanza. When allowing for interaction effects, our results suggest that EA membership might have mitigated the risk perception arising from higher government debt in the case of bonanzas.

Institutions, public debt and growth in Europe

This paper provides empirical evidence that supports the view that the quality of institutions is an important determinant of long-term growth in European countries. It shows that an initial high government debt level coupled with institutional quality below the EU average tends to be associated with particularly poor longterm real growth performance. Interestingly, the detrimental effect of high debt levels on long-term growth seems cushioned by the presence of very sound institutions. The paper offers some evidence that sound institutions may be particularly important for long-term growth in countries in which the exchange rate tool is no longer available and less so in countries with flexible exchange rate regimes. The empirical findings on the importance of institutions are robust to various measures of output growth, different measures of institutional indicators, different sample sizes, different country groupings and to the inclusions of additional control variables.

Mozambique – High Government Debt

Mozambique – High Government Debt

Does higher government debt link to higher social expenditure? New method, new evidence

ABSTRACTScholars believe that higher social expenditures are usually linked with higher government debts, whereas higher debts reduce social expenditures. However, it is reasonable to speculate that higher government debt may contribute to higher social spending, while fiscal deficits occur during a recession, which commonly creates greater demand for social expenditure. For a deeper investigation, this paper revisits the dynamic relationship between social spending and public debts in the time-frequency domain, using the novel wavelet-coherency analysis as well as the phase-difference technique to derive the co-moved and causal relationships between social spending and public debts in 13 OECD countries. The evidence identifies a dynamic relationship between variables. While higher social expenditures increase government debts, the shocks from government debts to social expenditures are conversely uncertain. We discover that higher government debt does reduce social expenditures, but it may be linked to higher social spending. The robustness of partial coherency and phase-difference discovers the role of a political party in the decision over social welfare programmes in the sample countries.

美国政府减税发债的财务可行性分析—基于净现值分析视角

本文以美国民主党和共和党在财政预算协议上的针锋相对而导致美国政府又一次“停摆”的事件为背景，从净现值的分析角度来说明了两党之争中何者的主张更具可行性。然后，借鉴这个思路，对我国地方政府债务过高的问题进行思考，到底地方政府债务风险是处于安全可控的状况，还是处于风险爆发前的蛰伏期，我们又该如何来看待地方政府债务高且快速增长的问题。本文结果表明，地方政府负债率的过高并不能说明其风险就很大，而应该从地方政府债务融资成本和债务资金投资收益的比较关系来看待地方政府债务的风险。 This paper takes the events that Democratic and Republican tit-for-tat on the budget agreement, which leads to the US government “lockout” once again as the background; the analysis from the perspective of net present value shows that which of the two Parties’ plan is more feasible. Then, we draw a lesson from this idea and think about the problem of high local government debt in our country, which help us assess whether the debt risk of local government is in a controllable condition or in the dormant period before the risk outbreak, and tell us how to treat the problems of high local government debt and its rapid growth. In this paper, the results show that high local government debt does not mean that the risk is very big, but rather should be from the comparison between the financing costs of local government debt and the ROI of debt capital to assess the risk of local government debt.

Public Debt and Private Firm Funding: Evidence from Chinese Cities

In China local public debt issuance between 2006 and 2013 crowded out investment by private manufacturing firms by tightening their funding constraints, while it did not affect state-owned and foreign firms. Using novel data for local public debt issuance, we establish this result in three ways. First, local public debt is inversely correlated with the city-level investment ratio of domestic private manufacturing firms. Instrumental variable regressions indicate that this link is causal. Second, local public debt has a larger negative effect on investment by private firms in industries more dependent on external funding. Finally, in cities with high government debt, firm-level investment is more sensitive to internal funding, also when this sensitivity is estimated jointly with the firm's likelihood of being credit-constrained. Altogether these results suggest that, by curtailing private investment, the massive public debt issuance associated with the post-2008 fiscal stimulus sapped long-term growth prospects in China.

Fiscal stabilization rule and overlapping generations

Recently important policy debate of both developed and emerging countries is about fiscal sustainability of government deficit. Fiscal authorities want to search for the fiscal stabilization rule that sustains their debt. We investigate how the fiscal stabilization rule sustains the government debt in overlapping generations model. If the fiscal stabilization rule which improves primary balance to an increase of government debt is sufficiently strong, there are two steady states; one is higher capital stock and output and lower government debt, and the other is lower capital stock which satisfies dynamic efficiency and higher government debt.

European Puttable Bonds: An Alternative Instrument for Managing the Sovereign Debt Crisis

We propose an alternative instrument for managing the risk of a European sovereign debt crisis that explicitly compensates the insurance guarantor for her risk-sharing activity: European Puttable Bonds (EPBs). EPBs are intended as a temporary and incentive-compatible refinancing instrument, simultaneously facilitating the rollover of sovereign debt, fostering crisis prevention efforts, and reducing the risk of multiple equilibria caused by high government debt levels. The paper's theoretical contribution is threefold: First, we model a financially distressed government's borrowing decision in the context of EPBs. Second, applying option pricing theory, we derive the embedded put option's corresponding strike and equilibrium price. Third, we determine the necessary magnitude of EPBs' conditional coercive measures in equilibrium. The calibration of our model to Portugal's pre-bailout situation in 2010 suggests that very reasonable conditional consumption restrictions (i.e., a reduction of less than 3% of GDP in case sovereign debt exceeds its sustainable limit) are sufficient to decrease expected government indebtedness. In equilibrium, the corresponding insurance premium (put option price) equals about 4% of the puttable bond's notional, which is significantly less than Portugal's accompanied potential savings from lower interest rates.

Foreign Direct Investment, Sovereign Debt and Growth: Evidence for the Euro Area

In light of the global financial crisis, an extensive implementation of fiscal stimulus packages has triggered an enormous soared of public debt in Europe. While grappling with this albatross, the high debt level has aroused the paramount interest of this study casts doubt on the role of sovereign debt towards the linkage between FDI and economic growth. To this end, this study aims to assess the effects of debt on growth through the channel of FDI in European countries by applying Pooled Mean Group (PMG) estimation. The empirical findings, by and large, suggest that a lower growth performance is evident with the association of high government debt through foreign investment. In a nutshell, over borrowing of public finance would crowd out private investment and hence stifle economic growth.
 JEL Classifications Code: F21, F34, F43, G01

The Impact of Government Debt on the Economic Growth of Ghana: A Time Series Analysis from 1990-2015

In this study we investigate the impact of government debt on the economic growth of Ghana adopting the methodology of the simple Ordinary Least Squares with data spanning from 1990 to 2015. Ghana has unfortunately found itself in the tragic situation of high external government debt which has led to high dependency on aid and other loans to support its development. These aids and loans have seen the debt of Ghana rise steadily over the years. As a result of the Heavily-Indebted Poor Countries (HIPC) which was presented by the IMF and World Bank in 1999, Ghana was judged to be a HIPC with unsustainable debt enabling the country to benefit from debt relief. We investigate the impact of government debt (both external and domestic) by testing three related models at the domestic and external levels including the general growth of the Ghanaian economy. In constructing our dataset, we build on the study of many scholars including a substantial amount of new materials from both primary and secondary data sources being Ministry of Finance (MOF) or Treasury Latest actual data: Government Finance Statistics Manual (GFSM), Ghana and World Bank. The research findings revealed that there is a negative relationship between debt (domestic and external) and growth in the economy of Ghana and recommend among others that government debt borrowing should be discouraged while increasing the revenue base through tax reform programs is encouraged.

Comments by Zhichao Zhang, on Monetary Policy and Structural Decline: Lessons from Japan for the European Crisis

Zhichao Zhang: Schnabl’s paper on Japanese lessons for the European crisis is informative and insightful. The paper carefully examines the origins of the crises, crisis triggers, and consequences of crisis therapies in both Japan and Europe. It then draws lessons from the Japanese experience in the spirit of Hayek (1929, 1944). The paper maintains that the Japanese case shows that, in the face of crisis, the Keynesian stimulus would lead to the malfunctioning of the market mechanism. This is evidenced in the hysteresis of the lowinterest rate and high government debt environment, the erosion of the allocation and signalling of the interest rate, the gradual quasi-nationalization of financial institutions, and gradual real income losses. Given that Europe has taken a similar path in its policy response to the crisis, the paper indicates that Europe may suffer similar consequences that Japan has experienced in recent decades.

Monetary Policy and Structural Decline: Lessons from Japan for the European Crisis

Japan experienced a boom-and-bust cycle in the real estate and stock markets almost 20 years earlier than Europe. Since the bursting of the Japanese bubble economy, the country has fallen into a deep recession and has experimented with crisis therapies in the form of unconventional monetary expansion, Keynesian fiscal stimulus, and recapitalization of financial institutions. Japan reached a low interest rate environment in the mid 1990s and has accumulated an exceptionally high level of public debt during more than two decades of economic stagnation. This paper compares the boom-and-bust cycles in Japan and Europe with respect to the reasons for excessive booms, the characteristics of the crises, and the (potential) effects of the crisis therapies. It is argued that in both Japan and Europe the consequences of expansionary monetary and fiscal policies include the hysteresis of a low-interest rate and high government debt environment, the erosion of the allocation and signaling functions of the interest rate, the gradual quasi-nationalization of financial institutions, as well as gradual real income losses. The economic policy implication for Europe and Japan is the timely exit from crisis therapies in the form of excessively expansionary monetary and fiscal policies.

Consequences of High Government Debt

Consequences of High Government Debt

Revisiting the Phillips Curve and the Lucas Critique

Many OECD countries are facing problems of high government debt and high unemployment. Consequently, a monetary stimulus is being increasingly viewed as a solution to curb the rising debt burden and stimulate economic growth. Some OECD countries are setting inflation target at 2% or even higher. In this paper we investigate the likely impact of inflation on unemployment for a panel of 10 highincome OECD countries, namely, Australia, Denmark, Iceland, Japan, Korea, New Zealand, Norway, Sweden, Switzerland and the United States. The period of study is 1970-2012. Results indicate a significantly positive long-run impact of inflation on unemployment. Granger causality indicates long-run bi-directional causality between inflation and unemployment. For the 10 OECD countries and the period of this study, the empirical findings support the Lucas critique: inflation and unemployment are positively correlated. A monetary stimulus, therefore, will most likely aggravate the unemployment scenario in the 10 OCED countries under study.

The Global Move into the Zero Interest Rate and High Debt Trap

The paper identifies based on the monetary overinvestment (malinvestment) theories by Wicksell (1898), Mises (1912) and Hayek (1929) monetary policy mistakes in large industrial countries issuing international currencies. It its argued that a benign neglect towards monetary policy reform in a world dominated by financial markets has led to a erosion of the allocation and signaling function of the interest rate, which has triggered an excessive rise of government debt and structural distortions in the world economy. The backlash of high government debt levels on monetary policy making is argued to lead to the hysteresis of low interest rates and high government debt levels. In this context, monetary reform is discussed with respect to the exit from low interest rates and high debt policies and a reform of the prevalent world monetary system. It is concluded that enhanced competition between dollar and euro as international currencies, which is refereed by East Asia, can be a promising approach towards a more stable world monetary system.

The Macroeconomic Policy Challenges of Balance Sheet Recession: Lessons from Japan for the European Crisis

The paper compares the boom-and-bust cycles in Japan and Europe with respect to the reasons for excessive booms, the characteristics of the crises, and the (potential) effects of the crisis therapies. As in Japan the consequence of expansionary monetary and fiscal policies is the hysteresis of the low-interest rate and high government debt environment, the erosion of the allocation and signaling function of the interest rate, the gradual quasi-nationalization of financial institutions as well as gradual real income losses, the economic policy implication for Japan and Europe is the timely exit from the current crisis therapies.

Self-fulfilling crises in the Eurozone: An empirical test

We test the hypothesis that the government bond markets in the Eurozone are more fragile and more susceptible to self-fulfilling liquidity crises than in stand-alone countries. We find evidence that a significant part of the surge in the spreads of the peripheral Eurozone countries during 2010–11 was disconnected from underlying increases in the debt to GDP ratios and fiscal space variables, and was associated with negative self-fulfilling market sentiments that became very strong since the end of 2010. We argue that this can drive member countries of the Eurozone into bad equilibria. We also find evidence that after years of neglecting high government debt, investors became increasingly worried about this in the Eurozone, and reacted by raising the spreads. No such worries developed in stand-alone countries despite the fact that debt to GDP ratios and fiscal space variables were equally high and increasing in these countries.

The impact of high government debt on economic growth and its channels: An empirical investigation for the euro area

This paper investigates the average impact of government debt on per-capita GDP growth in twelve euro area countries over a period of about 40 years starting in 1970. It finds a non-linear impact of debt on growth with a turning point – beyond which the government debt-to-GDP ratio has a negative impact on long-term growth – at about 90–100% of GDP. Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70 to 80% of GDP. The channels through which government debt is found to have a non-linear impact on the economic growth rate are private saving, public investment and total factor productivity.

Adjustment patterns to commodity terms of trade shocks: The role of exchange rate and international reserves policies

We analyze the way in which Latin American countries have adjusted to commodity terms of trade (CTOT) shocks in the 1970–2007 period. Specifically, we investigate the degree to which the active management of international reserves and exchange rates impacted the transmission of international price shocks to real exchange rates. We find that active reserve management not only lowers the short run impact of CTOT shocks significantly, but also affects the long run adjustment of REER, effectively lowering its volatility. We also show that relatively small increases in the average holdings of reserves by Latin American economies (to levels still well below other emerging regions current averages) would provide a policy tool as effective as a fixed exchange rate regime in insulating the economy from CTOT shocks. Reserve management could be an effective alternative to fiscal or currency policies for relatively trade closed countries and economies with relatively poor institutions or high government debt. Finally, we analyze the effects of active use of reserve accumulation aimed at smoothing REERs. The result support the view that “leaning against the wind” is potent, but more effective when intervening to support weak currencies rather than intervening to slow down the pace of real appreciation. The active reserve management reduces substantially REER volatility.