11

Kryzys fiskalny w EuropieKryzys fiskalny w Europie–– Strategie wyjStrategie wyjśściacia

Mark AllenMark Allenstastałły przedstawiciel MFW na Europy przedstawiciel MFW na Europęę CentralnCentralnąą

i Wschodnii Wschodniąą

110110 sseminarium eminarium BREBRE--CASECASEWarsWarszzawawaa, , 30 30 wrzewrześśniania 20201010

Presentation based on:

Fiscal Space Ostry, Ghosh, Kim and Qureshi SPN/10/11 (September 1, 2010)

Default in Today’s Advanced Economies: Unnecessary, Undesirable, and Unlikely Cottarelli, Forni, Gottschalk and Mauro SPN/10/12 (September 1, 2010)

Growth of debt has been very rapid Debt to GDP ratio

0 50 100 150 200 250

Austria Belgium Canada France

Germany Greece Ireland

Italy Japan

Netherlands Portugal

Spain Sweden

UK USA

2007 2009 2015

Recession, not stimulus, is to blame. G-20 Advanced Economies: Increase in Public Debt, 2008-15 (Total increase: 39.1 percentage points of GDP; 2009 PPP weighted GDP)

Revenue loss 19.2

Fiscal stimulus 4.5

Financial sector support

3.2

Lending operations

4.0

2010-2015 Interest-growth

dynamics 0.7

2008-2009 Interest-growth

dynamics 7.5

Sour

ce: W

orld

Eco

nom

ic O

utlo

ok, A

pril

2010

; Sta

ff e

stim

ates

Adjustment of primary balances starts in earnest in 2011

-3 -2 -1 0 1 2 3

Denmark

Germany

Sweden

Austria

Canada

USA

Netherlands

France

Italy

Japan

Belgium

UK

Ireland

Portugal

Spain

CAPB PB overall

0 1 2 3 4

Austria

Germany

Denmark

Japan

Sweden

Belgium

Italy

USA

Canada

France

Portugal

UK

Netherlands

Ireland

Spain

2009-2010 change 2010-2011 change

6.3

Some definitions

Debt limit Point at which debt dynamics become

unstable without exceptional fiscal effort

Fiscal space Room to borrow before hitting debt limit

Paper makes definitions operational and estimates

fiscal space in advanced economies

Simple dynamics of the debt limit Determination of Debt Limit

pb, (r-g)d

Debt/GDP d* d ~

Primary balance reaction function

Interest rate schedule with endogenous risk premium and default probability, p

d ˆ d _

(r(p)-g)d (r(0)-g)d

Conditionally stable long-run debt ratio

Debt limit (given cty’s historical

reaction function)

Reaction function looks plausible Primary Balance and lagged Debt to GDP

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

0 10 20 30 40 50 60 70 80 90 100 110 120 130 140

1st quartile

3rd quartile

Median

Lagged debt to GDP

Prim

ary

Bala

nce

to G

DP

Elements in the regression Dependent variable General government primary balance to

GDP Independent variables

Lagged debt (cubic)** Output gap*** Government expenditure gap*** Trade openness*** Inflation**

Age dependency (present and future) Commodity prices Political stability** IMF arrangement Fiscal rules

The interest-growth differential is deteriorating in some cases

Austria

Belgium

Canada France

Germany

Greece

Ireland

Italy

Japan Netherlands

Portugal

Spain

Sweden

UK

USA

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

-6 -5 -4 -3 -2 -1 0 1 2 3 Proj

ecte

d in

tere

st ra

te –

gro

wth

diff

eren

tial

(201

0-20

14)

Historical interest rate – growth differential (1998-2007)

45 degree line

0

50

100

150

200

250

300

Debt to GDP (2015) Equlibrium at historical market rates Equlibrium at projected market rates Equlibrium at model implied interest rates

2015 and stable debt levels (d*) Conditional long-run equilibrium

0

50

100

150

200

250

300

Debt to GDP (2015) Debt limit at historical market rates Debt limit at projected market rates Debt limit at model implied interest rates

2015 debt and debt limit (d) Model implied debt limit

_

Estimates of fiscal space Fiscal Space

(percent of GDP) p(FS>0) p(FS>50) p(FS>100)

Austria 93.4 0.81 0.81 0.38 Belgium 72.1 0.96 0.92 0.05 Canada 101.9 0.81 0.81 0.57 France 64.9 0.66 0.63 0.04 Germany 88.5 0.83 0.82 0.26 Greece 0 0.00 0.00 0.00 Ireland 63.6 0.61 0.59 0.04 Italy 0 0.00 0.00 0.00 Japan 0 0.00 0.00 0.00 Netherlands 91.3 0.81 0.81 0.35 Portugal 0 0.28 0.24 0.01 Spain 74 0.83 0.80 0.06 Sweden 130.2 0.71 0.71 0.71 UK 75.4 0.69 0.69 0.12 USA 63.4 0.82 0.71 0.03

Probability lower than 50%

Some points to note Estimates are based on historical

patterns and do not exclude exceptional responses

Shocks can push countries beyond their debt limit

Having fiscal space and using it are different things

Why do some commentators think default is inevitable?

Needed adjustment is too large Interest rates make debt burden

unsustainable Fiscal adjustment will hurt growth and

make debt unsustainable Once primary balance reaches balance

it makes sense to default

Markets have become worried about possible defaults

0

50

100

150

200

250

300

USA

Germany

Italy

UK

Japan

Source: Bloomberg

I. Financial crisis

buildup

II. Systemic outbreak

III. Systemic response

IV. Sovereign debt crisis

The Four Phases of the Crisis (5-yr sovereign swap spreads, basis points)

Particularly in some European countries

0

200

400

600

800

1000

1200 Belgium Greece Ireland Italy Portugal Spain Hungary Latvia

Source: Bloomberg

The Four Phases of the Crisis in Europe (5-yr sovereign swap spreads, basis points)

I. Financial crisis

buildup

II. Systemic outbreak

III. Systemic response

IV. Sovereign debt crisis

High spreads are not a very good predictor of default

1994 1995 1996 1997 1998 1999 2000 2001 2002 2004 2003

BGR BRA MEX

PER

COL BGR ALG PAK COL NGA ECU

NGA ECU NGA

TUR

HRV CDI UKR RUS LBN TUR DOM

POL VEN

ARG

MEX

UKR BRA VEN

ARG

RUS

MAR

ARG URU

MYS

ECU

Episodes where EMBI>1000

Spreads declined

Spreads remained high

Country defaulted

Evolution in the following 2 years:

Spreads declined until Lehman

Primary balance adjustment to stabilize debt

-12 -9 -6 -3 0 3 6 Ireland

USA

United Kingdom

Spain

Greece

Japan

France

Portugal

Netherlands

Italy

Cyclicaly Adjusted PB Residual PB Debt stabilizing PB after 50% debt haircut Debt stabilizing PB

6.4 (6.2)

7.6 (7.6)

4.7 (5)

7.1 (6.5)

15.5 (12.8)

6.4 (6.4)

4.5 (4.6)

5.8 (4.9)

4.2 (3.8)

0.8 (-0.1)

Debt stabilizing adjustment

(after haircut)

Other debt targets are important

Stabilizing debt at the 2012 level may not be sufficiently ambitious

In most cases further action would be needed to bring debt to 60 percent of GDP

Aging and health-care costs will require further adjustments

Recent large adjustment episodes Structural PB improved by more than 7 percent

Advanced (14) Belgium (1998), Canada (1999), Cyprus

(2007), Denmark (1986), Finland (2000), Greece (1995), Ireland (1989), Israel (1983), Italy (1993), Japan (1990), Portugal (1985), Sweden (1987), Sweden (2000), United Kingdom (2000)

Emerging Economies (26)

Episodes of large fiscal adjustment

-2 0 2 4 6 8

10 12 14 16 18 20 Expenditure reduction

Revenue Increase

Size of adjustment

Large fiscal adjustment experiences

11

7 7 7 4 6 3 15 14 4 7 12 8 4

Length (years)

Primary balance surpluses in large fiscal adjustments Large fiscal adjustment experiences

Ireland (1989)

Sweden (2000)

Finland (2000)

Sweden (1987)

Denmark (1986) Greece (1995)

Israel (1983)

Belgium (1998)

Canada (1999)

UK (2000) Japan (1990)

Italy (1993)

Portugal (1985)

-1

0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8 CAPB at End-Year

CA

PB a

vera

ge o

ver f

ive

year

s af

ter e

nd o

f th

e ad

just

men

t

How high debt ratios were reduced

-30

0

30

60

90

120

150

180 Residual G-I Primary Surplus Ending Debt Ratio Starting Debt Ratio

Interest-growth differential below past default episodes

-10

-5

0

5

10

15

20

25

30 Real growth rate (inverted scale) Real interest rate Real interest - Real growth

Real interest and real growth rates (2011-2012 or two years prior to default average)

60.7

Maturities longer than in past defaults

0

10

20

30

40

50

60

70

80

90

100

Advanced economies (2009)

Emerging economies (2005) Default cases

20,6 20,2

36,2

Share of short-term debt

The average maturity of Government debt gives countries time to adjust

0

2

4

6

8

10

12

14

16

Apr-09 Apr-10

Average maturity of sovereign debt

The structure of debt is more resilient Japan

Greece

USA Ireland

Spain

UK France Portugal

Netherlands

Italy

Argentina

Brazil

Chile

China

Colombia India

Indonesia Malaysia

Mexico Poland

Russia

Thailand

Phillippines

Turkey

Venezuela

Argentina (1981)

Argentina (2001)

Brazil (1982)

Chile (1982)

Indonesia (1998)

Mexico (1981)

Russia (1997)

Phillippines (1982) Venezuela (1981)

0

20

40

60

80

100

120

140

160

0 20 40 60 80 100 120

Advanced Economies (2009) Emerging Economies (2005) Default Cases (year prior to default)

Cen

tral G

over

nmen

t Deb

t to

GD

P

Local Currency share of Debt

Residency of holders discourages default in some cases

0% 20% 40% 60% 80% 100%

Austria Greece

Portugal Ireland

Netherlands France

Belgium USA

Germany Spain

Denmark Italy UK

Canada Japan

Residents

Non-residents

Some observations (1)

The primary balance surplus required to stabilize debt is not unprecedented.

Large deficits in some cases reflect recent wrong policy decisions which could be more easily reversed.

Once countries have incurred the initial pain of adjustment, they persevere and go to great lengths to avoid default.

The problem today is the large primary deficit, not high interest rates and a high interest bill.

Some observations (2)

Countries have time to convince the markets before their total government interest bill becomes too high.

Many countries have faced serious market tensions and similarly high spreads but could stabilize the situation.

Current market signals should not be interpreted as pointing to an inevitable negative outcome.

Main message of paper

A large fiscal adjustment is unavoidable for today’s advanced economies for a durable increase in economic growth.

A restructuring would be no substitute for the needed fiscal and structural reforms, and would be a distraction.

Thank you