Tuesday, June 30, 2009

SocGen: Public Finances - The Impossible Equation

The economists at Societe Generale have an "eye-opening" commentary on public finances today:
As public deficits are surging to unknown territories, the average debt ratio of the advanced G-20 countries is expected to jump by 20 points of GDP between 2007 and 2009 according to the latest IMF forecasts, and by nearly 40 points by 2014. This huge deterioration in public finances comes precisely at the moment when governments were supposed to make special efforts in order to face the fiscal consequences of an ageing population. Starting from now, the ageing population is expected to add 3% to 4% of GDP, or even 9% of GDP in the case of Spain, to public deficits in the next 30 to 40 years.
... One first goal could be to stabilise these debt ratios. This can be achieved easily if the difference between the rate of growth of the economy and the interest rate is positive, which was the case in the 70s when inflation was strong (see graphs below).
Click on chart to enlarge, courtesy of Societe Generale.

Said differently, the debt ratio stabilises if the economy manages to create enough revenues to compensate for the cost of the accumulated debt. But, without higher inflation, this is unlikely to be the case anytime soon as 1) interest rates have been abnormally low, and 2) GDP growth had been boosted by these abnormally low rates. The other solution would be to make painful efforts, i.e. the primary balance (which excludes interest payments) would have to be more and more positive. Otherwise, the debt ratio could very quickly reach the 100% threshold. Another goal could be to bring the debt ratio back to a level which allows room for manoeuvre in budgetary policy. The IMF has done some calculations to see what would imply a come back of debt ratios to 60% of GDP. Results are scary. They show that most of the countries, excluding Germany (1.8%) and Japan (14.3%!), would need to make an effort of 3% to 5% of GDP during the next 15 years to achieve this result. This looks simply out of reach, especially if every country pursues the same target at the same moment. Thus, back to the 70s?
As even maintaining near zero growth in US consumer spending requires immense fiscal stimulus these days, and any cyclical recovery depends on them, there is only one question:


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