- Most advanced industrial countries in worst ever peacetime fiscal shapeClick on chart to enlarge, courtesy of Citigroup Global Markets.
- Sovereign default can become the least bad solution for a country
- Sovereign default risk outside Greece low but non-negligible
- Most countries will eventually choose a ‘fiscal pain’ solution
- Debt restructuring, possibly with haircuts, likely to be part of the ‘fiscal pain’ package
- Inflationary solution to public debt burden highly unlikely in Europe, unlikely in US
- Euro Area needs mutual fiscal insurance mechanism to survive and prosper
- Restoring fiscal balance will be a drag on growth for years to come for advanced industrial countries
As for Ponzi scheme in the US, the prescription is straight forward:
For the US, with a structural primary deficit in 2009 of 7.3 percent of GDP, the arithmetic of solvency indicates the need for at least 7.3 percent of GDP worth of permanent fiscal tightening (not counting the long-term fiscal tightening required to accommodate future age-related public spending ambitions).
As to inflating away the real burden of debt:
The qualification ‘if the inflation was unexpected’ is important. The numerical decomposition of the change in the public debt-to-GDP ratio into its three components (and the growth-inflation interaction term) does not provide enough information to answer the counterfactual question: would a higher rate of inflation have lowered the public debt-to-GDP ratio more or faster? Only an unanticipated increase in the inflation rate reduces the real burden of servicing the debt over its entire lifetime. An anticipated increase in the rate of inflation raises both the nominal coupon payments and the nominal discount rates proportionally, leaving their real present discounted value unchanged.