Managing the Budget with High Debt and No Currency

A sovereign state with low debt can access liquidity through the markets. There are limits and they will be reached when the debt ratio begins to send out distress calls. Until that (unknown) point, there are, in effect, un-borrowed foreign exchange reserves. With an independent currency liquidity can be created for government or banks without external conditionality. There are limits here too and creating excess liquidity brings inflation risk and exchange rate pressure.
With high debt and hence uncertain access to bond markets a short-term expansion cannot safely be financed through debt sales without constraining capacity to repeat the procedure. Without a currency either, the creation of liquidity is conditional on the cooperation of the foreign central bank. If its conditions include constraints on fiscal action there can be no stabilisation policy – no exchange rate, no monetary or fiscal discretion.
Most Eurozone governments can borrow in the markets at low rates, courtesy of QE, despite historically high debt ratios. In the absence of QE the perception of capacity to borrow could diminish rapidly. Availability of QE is in any event not automatic – there is none for Greece, for example. There are also unclear conditions on ELA creation by national CBs. Consent from the ECB can be withdrawn arbitrarily or may be permitted only on penal conditions, such as pay-offs to unguaranteed creditors of bust banks.
The Eurozone governments with high debt face an illusion of policy space in current circumstances, with apparently easy access to debt markets. The constraint appears to be the EU rules about budgetary limits, as long as QE lasts.
But QE will end at some stage and the constraint becomes the market demand for sovereign debt. The design problem for fiscal policy (the only stabilisation tool available) is to manage the trade-off between using it now and having less to use later. Since the election Irish politicians have found agreement on two policies: (i) that the European Commission should be lobbied to relax the budget rules and (ii) that government should borrow ‘off balance sheet’.
Policy (i), lobbying the Commission, sacrifices future budget flexibility explicitly. The inverse demand curve for sovereign debt is r = f(D) where D is the debt ratio. Unless f(D) is flat the sacrifice is real. Moreover f(D) is unknown, although known not to be flat. Unless sovereign bond buyers are unable to count (ii), hiding sovereign liabilities, is just gaming the Eurostat debt definition. This definition (gross general government debt to gross output) is not a serious measure of debt servicing capability and, after QE, a sovereign could easily be inside some EU limit and unable to borrow. Eurostat does not lend money.
There are arguments for battling to borrow: interest costs are low and it is an article of faith that high-value public investment projects are plentiful. The trade-off (looser policy now versus the risk of ill-timed tightening later) would look better if the economy was becalmed, multipliers high, debt ratios modest, macro-volatility historically low and the foreign central bank known to be benign. None of these conditions applies currently in Ireland.
There is a case for using the QE respite to borrow reserves, accepting the negative carry, as NTMA appears to be doing. The case for deferring the attainment of budget balance is harder to see.



9 thoughts on “Managing the Budget with High Debt and No Currency”

  1. I do not know what normal is these days (nor do you Colm). I am as aware as your however that output in Ireland is remarkably volatile. Sensible arithmetic today will look either reckless or hairshirt in 12 months time. This should imply a fiscal stance which is reasonably but not excessively cautious.

    But if normal now means real interest rates of approximately zero then then orthodoxy needs re-thinking.
    Even an abrupt reversal in market sentiment (say a 500bp increase in the cost of new lending) would take a long time to feed through the stock of public debt. The average maturity is very, very long. In any case this reversal would likely be accompanied by surprise inflation and/or growth. So there is modest room to make mistakes and rein them in if necessary.

    I know that zero real interest rates are historically unusual. But they may be here to stay. If they are then things need to be re-thought.

      1. Of course.

        But 2018-2020 redemptions are about €55bn. If this ALL has to be re-financed at 5% you would have an additional debt service burden of a little under 1.5% of GDP.

        This would need some tightening to be sure to get back on track, but nothing like the experience of 1988-90 or even 2009-12.

        All against a baseline which is already a primary surplus of 4% in 2020. Of course growth (nationally or globally) can bring nasty surprises. But Ireland in 2016 (unlike 2006) has neither an overvalued REER or on oversized construction sector.

        When the numbers change, I change my mind, etc……..

  2. Eurozone government debt interest rates had corrected lower before QE, which only started in March 2015. The real impactor on pseudo-sovereign debt was the belief (misplaced or not) that Draghi was fully committed to using the ECB balance sheet to keep a State’s debt prices reasonably close to Germany’s through the OMT unicorn. If this faith slips, and it is thus implied that Eurozone members’ bonds are essentially more similar to Municipal bonds than Treasury bonds, then rates will explode higher all over again.

    Personally, I think the Italians are slowly realising that marrying themselves up to a New Deutschmark was a crazy decision that benefitted Germany far more than it did anybody else and that they should return to true sovereign-issuing status. Well, at least I *hope* they do.

  3. It must surely be accepted that what mainly drives budgetary decisions is the political assessment of those in power as to how these will play with the electorate. This DPER circular sets out the official provisions which, presumably, still apply and as set within the current EU constraints.
    The problem of course, lies in the way the “Ministerial Expenditure Ceilings” can so easily be varied (paragraph 10 at page 3). They simply cannot be considered as binding. The EU constraints are effective only to the extent that there is now some limit on aggregate budgetary expenditure. Otherwise, It is still mainly a question of throwing budgetary shapes. (The “rainy day fund” is a classic example). The extent to which there is political will to change, if at all, is not evident from the Summer Economic Statement (SES).
    What has changed, of course, is the nature of the government (a point to which the MOF drew repeated attention) i.e. a minority government for the first time in the history of the state).
    In a word, the real budgetary issue is the extent to which this changed situation limits the near-total flexibility available, and used, by the previous government with its large majority, when coupled with the EU imposed aggregate limits under the Preventative Arm of the SGP (however dubious the manner in which these are calculated).
    cf. pag 17 of the SES
    “This will be followed by the publication of the Mid-Year Expenditure Report (MYER) in July, which
    will set out the detailed expenditure context for Budget 2017. It will identify baseline Ministerial
    Expenditure Ceilings for all Departments. These ceilings, in addition to the analysis in this report,
    will provide the starting point for the examination by the relevant Sectoral Oireachtas
    Committees of budgetary priorities for 2017.”
    The essential characteristic of the new regime is, ostensibly at least, that increases must be offset elsewhere or funded by tax increases. Our politicians seem far from any real recognition of this.
    A related question is the extent to which the problem identified by the IM, and quoted by Michael Hennigan on another thread, can be resolved i.e. the lack of proper constant line by line budgetary structure. Maybe the MYER will be the first step in providing it.
    Every committee in the Dáil is, apparently, to be involved. This is a recipe for confusion in the absence of binding ceilings, and a fixed budgetary structure.

    1. This is the IMF reference from the post by Michael Hennigan..

      “The IMF report added:

      The lack of a comprehensive and exhaustive program classification…blurs the line of sight between policy objectives, resource allocations, expenditures, and outcomes and makes it difficult to prepare COFOG (Classification of the Functions of Government) based statistics on the functional distribution of expenditure without resort to estimation.”

  4. The Japanese have had near zero rates for 20 years and even before the financial crisis, rates were trending to low levels.

    Yesterday I saw on that a room in Jurys Inn Christchurch was selling for €359. This compared with about €110 in 2006.

    I wonder if pent-up wage pressure tied into rising rents and other costs that maybe masked by the overall CPI, is likely to be the biggest challenge.

    1979 was the worst year for Irish industrial disputes in the history of the State and came after 1978 when a public spending splurge pushed the budget deficit up to almost 18% of GDP.

  5. The lesson from 2009 is that if something goes wrong you are on your own. It is not merely that Ireland has high debt. It is part of a loose arrangement that does not have a Lender of Last Resort at a time when Central Banks can’t generate the 2% inflation needed to make debt safe. The global situation is chronic. Demand in the US is poleaxed. The Fed will not be able to raise rates. Over usd 10 tn in negative yield sovs. 10 year Treasuries will be negative by 2018. With high debt and ZIRP and the ECB Ireland has no margin for the next meltdown, the collapse of the debt Ponzi et son jus de Deleveraging.

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