Ludger Schuknecht has a long track record in writing on public finance (in the mid-2000s, he was prominent in highlighting the windfall nature of revenues associated with real estate booms). He is now with the German Ministry of Finance and this paper outlines one approach to solving the fiscal crisis.
Month: November 2011
There has been a lot of focus on the level of debt in Ireland. The household sector is suffering from a debt overhang as a result of the excesses of the previous decade, the government sector has seen its debt level soar as it tried to cover the losses in the banking sector and continues to run huge deficits, while the level of debt in the non-financial corporate sector appears enormous but seems to require a closer examination.
Using the CSO’s Institutional Sector Accounts it is possible to come with charts like the following (starting from when the dataset begins).
The lines in the chart represent the non-consolidated sum of the liabilities of each sector under three headings.
- AF2: Currency and Deposits
- AF3: Securities other than Equity
- AF4: Loans
The government is the only sector to have liabilities in all three categories as it had retail debt, government bonds and outstanding loans (mainly Promissory Notes) summing to €141 billion at the end of 2010. The corporate sector has both loan and outstanding debt securities, though loans make up 97% of the €347 billion total. The household sector has €185 billion of loans outstanding and is the only sector showing a declining level of debt.
The total of these is €673 billion which is equivalent to 430% of GDP or 526% of GNP. There has been much speculation about where these aggregates are headed over the next few years and whether a default of debt in any or all the sectors is imminent. A debt level in excess of 500% of GNP does suggest that only one conclusion can be drawn.
However, before declaring that the debt is “unsustainable” and can never be carried it is worthwhile to consider the actual burden that this level of debt is creating rather than simply focussing on the size of the debt.
Again we can turn to the CSO and this time to the Non-Financial Accounts and the interest expense in the Primary Allocation of Interest Account (item D41).
Two of the lines here appear to make sense. Household interest expenditure rises with interest rates and debt accumulation and peaks in 2008 at €8.1 billion and then falls as interest rates fell and debt was repaid and was €4.2 billion in 2010. The interest expenditure of the government begins to rise from 2008 due to well-known reasons and was €4.9 billion in 2010.
The pattern on interest expenditure by non-financial corporations does not present itself to such a straightforward analysis. This peaked in 2008 at €7 billion but in 2010 had fallen to just €712 million.
At 2.3% of the liabilities from the first chart, the interest for households appears low but the figure for non-financial corporations is startling given that we have just seen that they had €347 billion of potential liabilities requiring interest payments. Surely firms paid more than €712 million of interest in 2010?
One thing to note is that these accounts are non-consolidated so there could be intra-company loans in the total. Secondly, firms did make substantial payments in 2010 as distributed income of corporations (€18.0 billion) and as reinvested earnings on direct foreign investment (€14.6 billion).
The interest expense of government is set to increase over the coming years but lower interest rates and continued repayment will reduce the figure for households. The total for businesses remains an anomaly.
In total in 2010, the three sectors allocated €9.8 billion to interest. This is equal to 6.3% of GDP or 7.7% of GNP. Under neither measure does this look like an impossibly large burden but perhaps the discussion will unearth a deeper understanding of these figures.
I don’t think it is an exaggeration to say the next few weeks will be make or break for the euro zone. Four elements should be kept in mind:
1. Lacking a reliable lender of last resort to (large) states, the creditworthiness of countries with large debts and uncertain growth prospects is extremely fragile. Where any doubts exist about solvency, it is easy to shift to bad equilibrium, even where it is very likely that the state would not default if interest rates stay low. Ryan Avent at the Economist provides a good analysis here.
2. Introducing a credible lender of last resort creates big transfer-risk externalities. All euro zone countries should be wary of such a lender without some central controls on fiscal policies.
3. Even absent the need for central controls, euro zone countries would benefit from stronger national fiscal frameworks given the propensity to (structural) deficit bias. And some degree of external surveillance and enforcement can help to make those frameworks more credible. The cost of central controls should not be exaggerated.
4. It will be much harder to pull out of the crisis without the use of growth oriented macroeconomic policies where they are feasible. This applies to fiscal policy in countries where some degree of fiscal space exists, monetary policy and macro prudential policy.
The Financial Regulator, Matthew Elderfield, received a clamour of popular support recently when he publicly objected to the Irish domestic banks planned decision not to decrease variable mortgage rates in response to the ECB cut in interest rates. The political establishment was warmly enthusiastic for Elderfield’s intervention. The government used its shareholding and political muscle to ensure that the banks’ decisions were reversed. The government also offered to provide the financial regulator with legislative power to determine banks’ mortgage rates. Wiser heads within the Central Bank prevailed, and the government was told by the Central Bank “thanks, but no thanks” for the offer of new legal power to set retail mortgage rates.
The WSJ analyses the Irish austerity experience here.