public debt and the eu objectives
DESCRIPTION
PUBLIC DEBT and the EU Objectives. By the end of this lecture students should: Be aware of the significance of the intertemporal budget constraint Understand why and how a country can stabilise it’s debt Be able to apply the above to monetary union in the EU REF: Eufiscalteach nov09 - PowerPoint PPT PresentationTRANSCRIPT
PUBLIC DEBT and the EUObjectives
By the end of this lecture students should:
Be aware of the significance of the intertemporal budget constraint
Understand why and how a country can stabilise it’s debt
Be able to apply the above to monetary union in the EU
REF: Eufiscalteach nov09
Incl formulae
PUBLIC DEBT and the EU
Section 1
What is the government deficit?
Assumptions Ms constant lump sum tax autonomous
Government debt (D)(1) D = D-1 + rD-1 + G - Twhere:
D-1 = Govt. debt at the end of the previous periodrD-1 = interest paid on this debtG = Govt. spendingT = Taxes
Thus, budget deficit (BD) =
(2) D – D-1 = G + rD-1 - T
change in debt = Budget deficit
Rearrange
D – D-1 = G - T + rD-1
primary deficit debt service
Intertemporal budget constraints
Assume 2 time periods
Yr1 = G1 T1 Yr2 = G2 T2
No initial debt If G1 > T1 Yr2 must cover G2 + debt service T2 = G2+(G1 - T1) (1+r)
PUBLIC DEBT and the EU
Section 2
DEBT STABILISATION
1960’s - expanding debt no concern
1970’s - explosive increase in debt Debt stabilisation central to fiscal
policy See handout for EU data
GOVERNMENT SOLVENCY Real debt burden (ie;ratio of govt. debt to
GDP) doesn’t grow without limit Adjustment of primary budget balance
required total deficit = primary deficit + debt service
D = G - T + rD-1primary deficit debt service
Even if G=T for a year, debt rises (debt service)
Debt can be EXPLOSIVE! Primary surplus may be required
DEBT STABILISATION Explosive if r > g
debt accumulates faster than GDP grows (as 1970’s +)
If r < gratio debt to GDP can be
stabilised with budget deficit
Now consider in relation to GDP D = G - T + (r-g) D-
1
Y Y Y g= growth rate of econ r= r% on debt
Debt Explosive if r > g
p18
Primary surplus required to stabilise total debt to GDP ratioie: D = 0
YwhenT-G = (r-g) D-1
Y Yprimary budget surplus debt service
Examples-see worksheet
PUBLIC DEBT & INFLATION Central bank can now monetise
the debt Seigniorage No debt service - breaks link
making debt explosive Inflation tax Introduce seigniorage into formula
Now, smaller primary budget surplus required for stabilisation
Explosive nature of debt transferred to INFLATION
eg. Brazil, Russia
PUBLIC DEBT and the EU
Section 3
HOW TO STABILISE PUBLIC DEBT
DEFAULTExtreme
SEIGNIORAGE & INFLATION TAXReduces value of M0
Reduces value of public debt
REDUCE DEFICIT
REDUCE DEFICIT Raise tax / cut Govt. expenditure Politically/economically difficult
CoalitionsGerman unification
dependency ratiotax problems
eg. Distortions, ‘deadweight’ loss
Success?
UK ‘NEW FISCAL FRAMEWORK’
Deficit reduction plan Transparency Account for economic cycle Two rules
Golden Rule over cyclePublic debt - ‘stable &
prudent’ level Adopted by EU?
EU EXPERIENCE Maastricht criteria Stability & growth pact Rationale
fiscal discipline - debt is ‘explosive’ risk of ‘fiscal externalities’
danger ECB monetising debt See handout that links these
arguments to earlier theory
Euro area; Budget deficitdeficit (-)/surplus (+)Selected countries
(as a percentage of GDP)
Source: Adapted from ECB Monthly Bulletin Nov 2007 & ECB Statistics Pocket book Oct 2009
BL DE FR IT FI Euro area
2003
0 -4 -4.1 -3.5 2.5 -3.1
2004
0 -3.8 -3.6 -3.5 2.3 -2.8
2005
-2.3 -3.4 -2.9 -4.2 2.7 -2.6
2006
0.4 -1.6 -2.6 -4.4 3.8 -1.6
2009 Q1
-7.0
Euro area; Government debt(as a percentage of GDP)
Source: ECB Statistics Pocket book Oct 2009
2003
69.1
2004
69.4
2005
70.0
2006
68.2
2007
66.0
2008
67.5
2009
73.1
SGP problems
Loss of ER & monetary policy - fiscal policy is only policy left to States
OCA analysis suggests centralised budget - not possible
Thus, fiscal policy must be flexible to deal with negative shocks it is not under SGP State budgets not automatic stabilisers
in recession (national fiscal policy constrained)
SGP problems
Can rules be enforced? action against ‘offenders’ requires 2/3
maj in Council Evidence suggests more flexibility
would be ok evidence (DE Grauwe) that States in
monetary unions have lower budget deficits that individual States
risk of default in EU low (10yr bond yields have converged on German rates)
SGP problems
France & Germany 2003/04 SGP effectively suspended 2004-08? Future?
SGP problems
Greece 2009
CONCLUSION Debt stabilisation central to fiscal
policy Debt can be explosive Primary budget surplus important Stability & Growth Pact
does it constrain national fiscal policy in EU?
will it stop fiscal externalities in EU?
ADDITIONAL READING
Reading list, plus Gros & Thygesen, ch8 De Grauwe ch9 Bohn H, ‘The Behaviour of US Public Debt and Deficits’,
Quarterly Jnl of Economics, Aug 1998 Weale M, ‘Monetary and Fiscal Policy in Euroland’, Jnl of
Common Market Studies, March 1999 Balsssone & Franco,’Public Investment, the Stability
Pact and the ‘Golden rule’, Fiscal Studies (2000), vol. 21 Buti, Franco & Ongena,’Fiscal Discipline and Flexibility
in EMU: The Implementation of the Stability and Growth Pact, Oxford Economic Review, vol.14, no.3