«Public Debts: Nuts, Bolts and Worries Barry Eichengreen, Robert Feldman, Jeffrey Liebman, Jürgen von Hagen and Charles Wyplosz ICMB INTERNATIONAL ...»
On whether we should focus only on public debt in an environment when a part of the private debt can become public in a crisis, he observed that uncertainty about the size of this phenomenon is substantial. The risk is that people take seriously numbers based on arbitrary assumptions.
Finally, he pointed to the fact that the popular message from charts showing past trajectories of labour cost within the Eurozone assume that 1999 – the year when the euro was launched – was a year when real exchange rates were in equilibrium. Other normalisation assumptions provide a different impression.
In addition, it is not necessarily true that competitiveness needs to be regained by deflation. In fact, the countries that have competitiveness problems are those with very little productivity growth in the past and, therefore, some growth potential in the future.
The Political Economy of Fiscal Consolidation (Chapter 2) Stefan Gerlach, Managing Director, Institute for Monetary and Financial Stability, House of Finance, Goethe University of Frankfurt Stefan Gerlach congratulated the authors on writing a clear and informative chapter that reviews the important lessons. He underlined the importance of fiscal rules and deficit-limiting restricting laws in general. Looking at the problem of increasing or continuously high deficits through the lens of the political 126 Public Debts: Nuts, Bolts and Worries system and the game theory of politics is clearly appropriate. On the other hand, the question why fiscal rules are ineffective in some countries is not explicitly analysed. The main issue is that enforcement, which distorts the picture of effective fiscal rules, is simply inherent to certain forms of governance. He admitted that there might be a lack of counterfactuals to make a strong argument about enforcement.
Stefan Gerlach also agreed with the view that large deficits reflect structural problems, which, more often than not, stem directly from the way politics is institutionalised. He wondered whether there would also be a strong correlation between large deficits and alternative, more general indicators of governmentlike transparency or corruption. He has found such a strong correlation in his own research. He further suggested that history could yield further insight. Does a large debt in the past mean a large debt at present? Would the same approach allow the same conclusions in the context of the Gold Standard? Again, he was of the opinion that there is a strong correlation in both cases. In conclusion he said that the report does well to not try and answer the question of how to tax, but how to change the institutional framework.
Steven Cecchetti, Economic Adviser, Bank for International Settlements Steven Cecchetti presented some of his own findings, based on the comparison of deficit and debt forecasts up to 2040 with different policies implemented along the way. The lessons from this work are reasonably reassuring. First, switching to forward-looking budgeting processes, including multiyear budgeting, can have an immediate and important impact. Second, poor communication and lack of transparency often cause problems. Facing the common pool problem, democratically elected government officials and representatives can improve the dialogue with voters to transparently present the effects of policies and laws that they stand for. Third, countries that have created important reserve funds have performed much better in balancing budgets in the long run and in reacting to crises (eg Chile). Fourth, in most countries there is a dearth of economic research on long-term aspects of deficits and debt. Governments stand to benefit from knowing more and better, not in general terms – such as rules – but on how their own economy and political systems operate.
He then asked whether fiscal rules can really work. Noting that the introduction of fiscal rules is politically challenging, he thought that the Geneva Report could be of great help to make the issues at stake better understood. But he also pointed out that fiscal rules are not sufficient as such and that implementation is more complex than the presentation of the concept suggests. For fiscal rules to work there needs to be at least an independent agency that reviews their success and implementation, forecasts must be realistic and independently produced, communication should be clear and based on maximum disclosure, and independent research must be developed. Fiscal policy is at least as complex as monetary policy and yet research seems to have been neglected so far. He concluded that this report is a step in the right direction, a welcome effort to shift the focus to a certain degree.
Discussion 127 Lars Nyberg, Deputy Governor, Sveriges Riksbank Lars Nyberg presented the experience of Sweden, a country that has achieved over the past years a good track record in terms of managing fiscal policy and debt, unlike most of the countries analysed. He said that governments seem to have short memories though. He recalled that for several centuries everyone said they would never again bring themselves into a situation, where the incentives favour spending much more than saving.
When Sweden had a problem of rising debt in 1992, it devalued. Growth was fuelled by exports, which helped significantly. Yet, it took until about 1998 for public finances to be brought back into order. The strategy has been carefully discussed, around the principle that ‘He who is in debt is not free’. Sweden now has adopted an expenditure ceiling, a key part of the effort to reduce deficit spending. There is also a goal to achieve a budget surplus of at least 1% per year.
In addition, regional budgets must be balanced. Parliament decides on budgets 3 years ahead, and they cannot be altered any more after that. This ensures that spending focuses on long-term needs, rather than short-term interests. Loopholes exist, especially in the details, but this has not caused large problems so far. One reason why the system has remained stable is that buffers were introduced to balance budgets in times of need. The main buffer is the 1% surplus target. In addition to planning budgets three years ahead, and setting them in stone, parliamentarians are also required to propose plans for financing any project that they wish to introduce. The experience is that it is particularly difficult to stick to the plan when things are going well, when pressure grows to increase spending on health care or education.
Hans-Jörg Rudloff, Chairman, Barclays Capital Giving his personal opinion as a practitioner, Hans-Jörg Rudloff started by asking: ‘How will we continue to finance all this debt?’ He said that the markets – banks, insurance companies, asset managers and more – have massively failed to give the right signals when it became clear that there was a big problem with sovereign debts. They should have said that they would no longer accept the piling up of debt to the extent reached in the European Union. The yield curve across the European Union was essentially flat before the start of the financial crisis. That is extraordinary. The market did not just fail to send the right signal, they sent the wrong one.
When Greece was found to be in crisis (Sunday 9 May 2010), it still needed money. They got it on Tuesday, 11 May 2010. This is another example of a wrong signal, namely that the financial markets would continue to finance public debt, even for Greece, and even after it became clear that the government could no longer service its debt. Huge short positions had been built up at this point.
Obviously, market participants knew what would happen. They even knew who held the short positions. Unfortunately the banks would not do themselves a favour by making their actions more transparent, which is why it was hard for counterparties to understand what was going on.
Now all relevant parties know that some Eurozone countries will need to refinance their debt soon. The amounts of money in question are large, and 128 Public Debts: Nuts, Bolts and Worries they will have to be rolled over at some point or another. If governments fail to act now, things will only get worse, he said. He also pointed out that there is no functioning mechanism to address the issue because adequate institutions are missing. In his view, governments are still far from being in a position to handle what may be coming. He also said that, in general, we are far from having reached a system that could function in a crisis, especially because restructuring is not an attractive option, not least for practical reasons.
General Discussion Hans Genberg, Assistant Director, Independent Evaluation Office of the IMF Hans Genberg highlighted the importance of independent forecasts for GDP, because governments have an incentive to produce optimistic forecasts of GDP growth, in order to be able to spend more. He questioned the approach of viewing the issue of large debts only as a result of institutions. He noted that it could also be a question of mentality. To underline the statement he pointed out that Greece already had the highest debt to GDP ratio under the gold standard. Given that background, can we even change institutions?
Richard Portes, Porfessor of Economics, London Business School and President of CEPR Richard Portes suggested that the effectiveness of fiscal councils could be overestimated. Reacting to calls for independent forecasts, he pointed out that it has become more difficult to forecast GDP growth. The confidence intervals of forecasts have grown over the past years, so it would be unwise to delegate such a complex task to a fiscal council. Independent forecasts should come from the private sector consensus forecast to limit reputation loss and to increase accuracy. He added that it would be difficult to safeguard the independence of such institutions, particularly because cooperation with government and civil servants is one of the goals.
Ivan Adamovich, Member of Executive Management, Wegelin & Co.
Ivan Adamovich thought that the estimates of implicit debts presented in Chapters 3 to 5 were moderate compared to other forecasts. Concerning retirement benefits, he observed that there is simply no one with a strong interest in undertaking fundamental medium-term reforms. Do we have to accept that reforms are simply achieved because of good luck? The serious issue, he suggested, is not how to do the best reforms but how to start reforms. He suggested that the Geneva Report should also take into account that investors are now moving away from public debts.
Jean-Pierre Landau, Deputy Director, Banque de France Responding to Ivan Adamovich, Jean-Pierre Landau asked where investors who move away from government bonds go to. Corporate bonds is one option, but is the market deep enough? Safer? What are the alternative investment vehicles?
He remarked that these are essential questions.
Discussion 129 Jaques Delpla, Economist, Conseil d’Analyse Economique Jaques Delpla thought that incentives should play a larger role in possible solutions. The Geneva Report spends a lot of time looking for first best solutions but what about more realistic second best strategies? How could that look? In France, for example, there will not be a majority for a fiscal rule.
Edwin Truman, Senior Fellow, Peterson Institute for International Economics Edwin Truman reminded the audience that we have had a common pool problem for centuries. Almost everything that is recommended as a solution in the report, or presented by Steven Cecchetti, has been tried out or done. This does not necessarily mean that previous actions were failures, but it might mean that we have to go through the same cycle again and again, maybe every 15 or 20 or 50 years. This could simply mean that institutions and processes erode over time. The efforts are not fruitless, but the phenomenon is a typical characteristic of the political economy. Presenting the issue in this light might be helpful, he suggested.
Jürgen Von Hagen, Professor of Economics, Bonn University ürgen Von Hagen answered some of the questions. First he pointed out that institutional reforms happen in periods of crisis. This is when institutions are reformed and improved. Is it the new institution that does the consolidation, or rather the consensus that something needs to be done? He argued that it is a mixture of both. However, it is the institutions that help make the memory of the crises stick in the years afterwards and that is when they become important.
As for Europe, he said that the common currency is the main reason for the European Union to deal with the issue. The common currency means that the countries can no longer independently react to adverse shocks. He mentioned the example of France’s move from the Fourth to the Fifth Republic, when a fiscal crisis led to important institutional reforms. Denmark, the Netherlands, and Sweden also enacted reforms that proved to be successful and sustainable.
He also reacted to the comment that France had no interest in a fiscal rule. He said that a fiscal rule in France would be silly, because France is not a contractual system. This is one of the central points of Chapter 2; fiscal rules and reform in general have to fit the system of the country where it should be applied.
As for forecast, he observed that the problem is not accuracy but bias, and here again political institutions matter. Consistently biased forecasts of GDP, where the forecast of GDP growth is biased downwards and expenditures upwards, is typical of a contract country, because a coalition is in a much better position when it rewrites the contract if there is a surplus rather than a deficit.
In a delegation country, we observe the exact opposite, and that is where an independent forecast should play a big role.
Jeffrey Liebman, Professor of Public Policy, Harvard University Jeffrey Liebman stated that, in the USA, the forecasts of the CBO have performed well. They provide a good basis for the debate on adjustments that have to be 130 Public Debts: Nuts, Bolts and Worries done. Of course the components of an adjustment still need to be discussed. He also underlined that the process of setting up institutions that can address the issue takes several years.
Charles Wyplosz, Professor of International Economics, the Graduate Institute of International and Development Studies and Director, ICMB, CEPR Charles Wyplosz picked up the issue of incentive. The key idea of the report is that if you can internalise the incentives you no longer have a common pool problem. Responding to Stefan Gerlach, he cited works that show that the common pool problem tends to be stronger the more heterogeneous a population is. It is therefore quite probable that there are long-lasting differences between countries. This is not in contradiction with the theory.
Robert Feldman, Managing Director, Morgan Stanley MUFG Robert Feldman quoted the Crisis-Response-Improvement-Complacency (CRIC) model that he has been using for the past 15 years in Japan. The model is very easy to grasp. On the horizontal axis you have growth of the stock market; on the vertical axis, you have the extent of reform currently undertaken. An upward sloping line represents the notion that the more reforms are undertaken, the better the economy will perform. The political side is captured by a downward sloping line: the better the economy performs, the less incentive there is to push for reform. This suggests that crisis is necessary for reform, as observed by Jürgen Von Hagen. It also indicates that the response to the crisis is more effective where solutions are readily available. The question that the report explores is how to reform the process of reform. He then supported the view that using a weighted average of private forecasts would make sense. On the use of incentives, he mentioned civil servants’ contract in Singapore as a good example.
Alexander Swoboda, Emeritus Professor of Economics, Graduate Institute of International and Development Studies Alexander Swoboda saw an additional dimension to the role of growth and crises in shaping incentives for reform, namely whether the crisis is international or national. The response to the crisis should be very different in each case. Drawing on the case of Switzerland, he noted that forecasts have been rather conservative recently. This observation made him think that a country’s performance in dealing with its public debt follows a historical average.