«Public Debts: Nuts, Bolts and Worries Barry Eichengreen, Robert Feldman, Jeffrey Liebman, Jürgen von Hagen and Charles Wyplosz ICMB INTERNATIONAL ...»
David Ramsden, HM Treasury, London David Ramsden focused on the UK, drawing on his experience on crisis response and consolidation. As a fiscal policymaker, he liked the institutional approach, which resonated well with the UK experience. The report correctly argues that there is no one-size-fits-all when it comes to stabilisation policies or institutional constructions. Unlike the authors, however, he was optimistic about the potential of supply-side policies to have a beneficial impact. He also thought that the report was too critical of quantification. He did not think that the rules of thumb, such as the 90% debt-GDP ratio, always apply but they can serve as a stabilisation objective. In addition, clear rules or rules of thumb help to focus the minds of policymakers, offering a reference for comparisons with previous historical episodes and with other countries. He also advocated the use of IMF data and especially the IMF Fiscal Sustainability Risk Map for Advanced Economies, in fact quite close to the Geneva Report’s focus on policy implementation.
David Ramsden flagged three types of risks. First, he was concerned with the health of the financial sector. When the banking sector is large, the riskiness of banks’ assets contributes significantly to sovereign risk. Indeed, in 2010 countries with large financial sectors tended to post large primary structural deficits.
Second, demographics constitute a long-term challenge because of uncertainties in estimating the scope of the associated risks. For instance, estimates of future health care spending in the UK are very sensitive to assumptions about technological changes. In this kind of situation, he argued, an independent fiscal council can make a sizeable contribution in publishing reports on sustainability.
The third risk concerns macroeconomic uncertainty. According to the IMF, a clear fiscal strategy can reduce uncertainty and hence support confidence. In order to deal with the tail risk of a very nasty fiscal outcome, the UK has already started fiscal consolidation. Although in the short term, the consolidation seems to have an adverse impact on growth, one has to consider the counterfactual. Here again fiscal councils would have a role to play in setting figures that can serve as a basis for decision making, for example by estimating cyclically adjusted budgets or by showing the cost of inflation for the public sector in order to mitigate fears of monetisation.
Jean Pisani-Ferry, Director, Bruegel, Brussels Jean Pisani-Ferry wanted to distinguish some implicit assumptions that the report makes among countries. It assumes that, in the USA, the financial crisis had a major cyclical component while in Europe the shock was more structural and that the output is lost forever. Is that certain? Also, looking to the future by assuming that policy is constant can be misleading, when it is in fact unsustainable.
Akira Kohsaka, Professor, School of International Studies, Kwansei Gakuin University, Hyogo Commenting on Japan, Akira Kosaka felt that Chapter 5 overemphasised the lack of transparency in Japanese budget figures, while Japan is really not an exception.
He also noted that decision rules that impose a medium-term constraint on policy cannot be easily changed. Finally, he agreed on the importance of ending deflation. Japan has gone through 10-year cycles of fiscal consolidation: in the 1980s, fiscal consolidation was successful in Japan, in contrast with most other OECD countries. Then, in the 1990s, the situation turned around and Japan’s fiscal situation deteriorated significantly. In the 2000s Japan was again unsuccessful in consolidating its public finances. Hence, the lost decade turned out to stretch to two lost decades. Ending deflation should be taken as the top priority. Reacting to Kazumasa Iwata’s proposed tax reforms, Akira Kohsaka suggested that easy money can also be a part of the solution, for example the Bank of Japan could purchase government bonds.
Alexander Swoboda, Emeritus Professor of Economics, The Graduate Institute of International and Development Studies, Geneva Alexander Swoboda thought that, indeed, more should be said about the possibility of reducing the stock of debt through inflation. Even though in the case of Japan, this does not come naturally to mind because of persistent deflation, for the other two cases, the USA and the EU, this prospect should be more seriously discussed. This would raise serious questions of international coordination. Within the G20, for example, China has been reacting to the depreciation of the dollar. He also indicated that he remained unconvinced by the ‘no-size-fits-all’ view as too easy a criticism of some policies. For him, the real question is to find a general rule or policy that would be acceptable by individual countries.
Angel Ubide, Director of Global Economics, Tudor Investment Corporation, Washington DC Angel Ubide wanted to hear more on why we should be worried by high public debts. The markets focus on countries with high levels of debt when accompanied by current account deficits. It is not just a question of the size of the debt, but who owns the debt and how it is financed matters. He claimed that if we cannot explain why Japan has not had a crisis already, we need not worry by debt increases in other countries.
122 Public Debts: Nuts, Bolts and Worries Ignazio Visco, Member of the Governing Board and Deputy Director General, Banca d’Italia, Roma Ignazio Visco agreed that more attention should be given to the differences in net foreign positions. He also mentioned the extreme home bias of Japanese investors, who hold 90% of the Japanese public debt. The question is how important is this fact and what would need to happen to change it, especially since most crises happen when people try to move capital abroad.
Robert Feldman, Managing Director, Morgan Stanley, Tokyo Robert Feldman disagreed with Akira Kosaka who asserted that the lack of transparency of Japanese public accounts was in line with what can be found in other developed countries. At any rate, the lack of transparency in other countries should not be an excuse for Japan. He also took exception with the view that political institutions cannot be changed. This is simply a question of political will. On the other hand, he agreed on the need to end deflation.
Concerning the channels through which a more aggressive policy by the Bank of Japan might operate, he mentioned the foreign exchange rate, land prices and asset prices in general, as well as investment spending. He was amazed that there was no debate on the real interest rate: if the Bank of Japan succeeds in increasing inflation, the real interest rate will go down which would stimulate investment and productivity growth.
On the issue of inflating the debt away, he quoted Reinhart and Rogoff (2009):
why do the young people not rise up, generate inflation and take the wealth from the old generation? In his view, inflation is politically the easiest (and probably fairest) way to reduce the public debt, since it is politically very hard to raise taxes or cut spending. He also indicated that he was sceptical about the fairness of the ‘social contract’ because it is in fact the currently old generation that voted on benefits that need to be paid by people that were not involved in the decisionmaking process. It was not society that made promises to the old generation, they made those promises to themselves.
Finally, he commented on the home bias question and on the prospects of a bond market crisis in Japan. He warned against mixing up stocks and flows. The stock view is that 90% of bonds are owned at home, largely because investing abroad is perceived to be dangerous. Looking at flows, however, he noted that savings are likely to diminish while investment will not decrease by as much, in part because of the earthquake. In the end, there will not be enough money to fund the larger deficits over time and the Bank of Japan will end up printing money. He also pointed out that there already were a couple of small crises that got contained in the end, for example in the autumn of 2009. If the debt increases further, it will get to a level where such tax revenues will not be sufficient to cover the interest payments.
that the debt decreased so rapidly because of high inflation, the real story is much more about strong GDP growth (4% GDP growth, 3.5% inflation). It is often said that high inflation will not be effective in resolving indebtedness unless it is a surprise. However, inflation will reduce the initial stock of debt because interest rates are fixed (at least in the USA). Hence, with a look at the fact that the Fed does not have an inflation target, the question is whether the USA could not try a different mix this time, for example 4% inflation and 3% GDP growth.
About Japan, Eric Chaney felt that market feedback is an important part of the story. Even though market discipline did not work in Europe, it might come back through some structural changes. In the case of the USA, he was sympathetic with the thesis that it was the imbalance between supply and demand of reserve assets that was responsible for low interest rates before the crisis. But now, China has decided to change policy and focus more on domestic demand. As a result, in the first quarter of 2011 China was running a current account deficit. This is an example of structural changes that can lead to higher interest rates and that would amplify the policy reaction.
All in all, market discipline is extremely useful. In the case of Europe, without a good crisis, there would be no reform of governance in the Eurozone. He suggested that it is also needed to talk about debt restructuring. This could awaken market discipline and send a shock wave not only through the Eurozone but also to other OECD countries such as the UK.
Amlan Roy, Managing Director, Credit Suisse (Securities) Europe Limited Amlan Roy quoted his own projections showing that the current account in Japan will go negative much earlier because of adverse demographics. On the topic of transparency and implicit liabilities, he mentioned that the present value of deficit from US state pension plans not accounted for stands at $5 trillion. The US government is allowing discounting future liabilities at the rate of 8% while none of the plans is making returns higher than 1%. Implicit liabilities in health programmes provide another example of huge implicit liabilities.
Richard Portes, Professor of Economics, London Business School; President, CEPR, London Richard Portes disagreed with the framework of the report. In his view, there are two long-run fiscal issues: health care and pensions. The demographic problem needs to be solved by reforming the labour market. If the retirement age does not increase in line with life expectancy, then the living standards of the retired people have to fall relative to those who work. Alternatively, those who work have to make higher transfers to those who do not work. In this case, fiscal policy is irrelevant: the key is to make people work longer. The share of working people in the population determines the overall size of the intergenerational transfer.
From this point of view, it is mainly a labour market problem, not a fiscal one.
Dino Kos, Managing Director, Hamiltonian Associates Ltd., New York Dino Kos suggested looking at the example of Canada. In the early 1990s Canada was regarded as a hopeless case. Yet, thanks to tough decisions and with some luck 124 Public Debts: Nuts, Bolts and Worries they managed to improve their fiscal situation. He also agreed that it is important not to overlook implicit liabilities. If focus is centred solely on the public debt, politicians will move everything out of the balance sheet. For example, in 1968 the Johnson administration privatised Fannie Mae exactly in order to get it off the public sector balance sheet.
Luigi Buttiglione, Head of Global Strategy, Brevan Howard Investment Products Limited, Geneva According to Luigi Buttiglione, the Eurozone is facing a joint problem of competiveness and debt stabilisation. The countries that want to regain competitiveness within the Eurozone need deflation. On the other hand, with debt stabilisation it is inflation that would help.
Thomas Jordan, Vice Chairman of the Governing Board, Swiss National Bank, Bern Concerning the topic of fiscal versus monetary dominance, Thomas Jordan agreed that generating inflation was not a good idea. However, what matters is not what central bankers think but what politicians decide. Although at the moment we have monetary dominance, this should not be taken for granted. If debt levels keep increasing, the situation might change completely. Regarding fiscal stabilisation in the USA, he observed that it has been previously mentioned that the correction should come both from the spending and the tax side.
Now, however, it is often asserted that the correction should come mainly from spending cuts because the US tax system is too distortionary.
Laurence Boone, Chief Economist, Barclays Capital, Paris Laurence Boone asked how the Eurozone can grow with such a high level of debt.
She also wondered what will happen if the adjustment strategy fails. Restructuring the Greek debt would be an example of such a failure and she was wondering how the Eurozone would deal with it.
Jacques Delpla, Economist, Conseil d’analyse economique, Paris While the report emphasised the supply side of the public debt, Jacques Delpla felt that more attention should be paid to the demand side, that is, reactions of the market. Another important aspect to consider is that the fact that the European Stability Mechanism (ESM) will be a senior creditor will send an important signal to investors on what would happen in case of restructuring. This is why interest rates cannot be taken as fixed; they will play an even larger role in the future.
Jeffrey Liebman, Professor of Public Policy, Harvard University, Cambridge, MA Jeffrey Liebman sought to explain pessimism about potential growth compared to past experience. While productivity growth is likely to be the same as in the past, the important factor that distinguished the current situation is that labour force growth is going to be slower because of the demographics. He also commented on the tax versus spending split of fiscal stabilisation. Currently, the USA is on a trajectory with increasing spending as a share of GDP. Some people see this as a proof of expanding government, while it is only a predictable effect Discussion 125 of the ageing of the society. As a consequence, there is no easy spending splurge that can be reversed; reducing spending would mean reducing entitlements of the old generation. It is politically feasible to cut pension spending or to stem the increase in health care costs, but that cannot be done earlier than in 3–5 years.
Thus, if one is committed to acting fast, it is the revenues that must be increased.
In the longer run, government spending depends on how much state-of-the-art health care the USA wants to consume. Most of the research suggests that the benefits of spending on health care still exceed the costs. This means that when cutting expenditures one would need to focus on low-value health care spending.
Charles Wyplosz, Professor of International Economics, The Graduate Institute of International and Development Studies; Director, ICMB, Geneva Charles Wyplosz acknowledged that the report does not take into account the demand side of the government bond market. The reason is a conscious choice not to be driven by the debt crises, which is the object of much work elsewhere. He next indicated that he had serious doubts about the usefulness of debt sustainability measures. For example, the Portuguese debt was deemed sustainable 6 months ago, then it increased by a negligible amount and suddenly the markets decided it is not sustainable. Sustainability, he claimed, cannot be measured; instead it is driven by market sentiment.
On the topic of supply-side policies and growth, he noted that raising real GDP growth by 1% can make a huge difference. However, implementing supply-side policies is politically as difficult as dealing with budget deficits because generally they both affect the same groups of people.