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Fiscal Policy & Financial Crisis Implications:

Part II
EC 413 LSE

Wouter J. Den Haan

This Lecture

A. Sovereign debt sustainability in theory


B. Looking at the data

IMF World Economic Outlook 2013 (October)

Sustainable debt

D: nominal government debt


Y: nominal GDP
S: the nominal primary surplus (revenues minus expenses before interest payments)
r: nominal interest rate
g: nominal growth rate of Y

Sustainable debt

Dt+1 = (1+r) Dt - St+1


Divide through by Yt+1
Dt+1 / Yt+1

= (1+r) Dt/ Yt+1

- St+1 / Yt+1

= (1+r)[Dt/ Yt][Yt / Yt+1]

- St+1 / Yt+1

= [(1+r)/(1+g)] Dt/ Yt

- St+1 / Yt+1

Sustainable debt

Dt+1 / Yt+1

= [(1+r)/(1+g)] Dt/ Yt

- St+1 / Yt+1

or

dt+1

(1+r-g) dt

- st+1

With:
dt

= Dt/Yt

st

= St/Yt

!!! Everything is in real terms now

Sustainable debt

dt+1

(1+r-g) dt

- st+1

Case I: r > g
s < 0 in every period debt level explodes
s = 0 in every period debt level explodes
s < (r-g)dt in every period debt level still explodes
surplus is too small
s = (r-g)dt in every period debt level is constant
s > (r-g)dt in every period debt level becomes smaller
you need a sufficiently large surplus to stabilize debt
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Sustainable debt

dt+1

(1+r-g) dt

- st+1

Case II: r < g


s 0 in every period debt level
s < 0 but s > -(g-r)dt debt level
even with a deficit you can have stable debt levels
s < -(g-r)dt in every period debt but stabilizes
debt stabilizes but could be at a high level !!!
and then r could increase and then

Governments financial balances: France


2.0
1.0
0.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
1.0
2.0
3.0

primaryunderlying
structural

4.0

total

5.0
6.0
7.0
8.0
9.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

Governments financial balances: Greece


10.0

5.0

0.0
19961997199819992000200120022003200420052006200720082009201020112012201320142015
primaryunderlying
5.0

structural
total

10.0

15.0

20.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Governments financial balances: Iceland


10.0

5.0

0.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
primaryunderlying
5.0

structural
total

10.0

15.0

20.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Governments financial balances: Ireland


10.0

5.0

0.0
19961997199819992000200120022003200420052006200720082009201020112012201320142015
5.0

10.0

primaryunderlying
structural

15.0

total

20.0

25.0

30.0

35.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Governments financial balances: Spain


4.0

2.0

0.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2.0
primaryunderlying
4.0

structural
total

6.0

8.0

10.0

12.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Governments financial balances: UK


8.0
6.0
4.0
2.0
0.0
2.0

primaryunderlying
structural

4.0

total

6.0
8.0
10.0
12.0
14.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Governments financial balances: US


4.0

2.0

0.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2.0

4.0

primaryunderlying
structural

6.0

total

8.0

10.0

12.0

14.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Governments financial balances: Euro-Area


3.0

2.0

1.0

0.0
19961997199819992000200120022003200420052006200720082009201020112012201320142015
1.0
primaryunderlying
2.0

structural
total

3.0

4.0

5.0

6.0

7.0
Legend:
primary denotes underlying primary balance, i.e., adjusted for the cycle and for one-offs and excludes interest payments
underlying means adjusted for the cycle and for one-offs
structural means adjusted for the cycle
Source: OECD data

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Who has sustainable debt?

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Source:IstheEuropeanSovereignDebtCrisisSolved?
WellsFargoSpecialCommentary
https://www08.wellsfargomedia.com/downloads/pdf/com/insights/economics/internationalreports/Is_the_European_Sovereign_Debt_Crisis_Solved_01272014.pdf

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Source:IstheEuropeanSovereignDebtCrisisSolved?
WellsFargoSpecialCommentary
https://www08.wellsfargomedia.com/downloads/pdf/com/insights/economics/internationalreports/Is_the_European_Sovereign_Debt_Crisis_Solved_01272014.pdf

19

Source:IstheEuropeanSovereignDebtCrisisSolved?
WellsFargoSpecialCommentary
https://www08.wellsfargomedia.com/downloads/pdf/com/insights/economics/internationalreports/Is_the_European_Sovereign_Debt_Crisis_Solved_01272014.pdf

20

Source:IstheEuropeanSovereignDebtCrisisSolved?
WellsFargoSpecialCommentary
https://www08.wellsfargomedia.com/downloads/pdf/com/insights/economics/internationalreports/Is_the_European_Sovereign_Debt_Crisis_Solved_01272014.pdf

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Source:IstheEuropeanSovereignDebtCrisisSolved?
WellsFargoSpecialCommentary
https://www08.wellsfargomedia.com/downloads/pdf/com/insights/economics/internationalreports/Is_the_European_Sovereign_Debt_Crisis_Solved_01272014.pdf

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