Journal of Financial Economics REF 146
The Sustainability of Public Debts
The Sustainability of Public Debts
Olivier Blanchard's latest book (Les grands défis économiques), his recent publications and his numerous contributions to the public debate allow us to organize our discussion on optimal policy, which is a mix between a traditional view of monetary policy and a view that thinks of fiscal policy as the main instrument of stabilization; optimal policy is between the two, and depends, among other things, on the dynamism of private demand. The discussion between Olivier Blanchard, Jean-Paul Pollin and Xavier Ragot is therefore divided into three parts, on low interest rates, on the sustainability of public debt and on the consequences for the definition of optimal policies in Europe and in France.
Lessons from some Historical Experiences
How have societies coped with large increases in public debt? in the European history of the last three centuries, these moments have occurred mainly during and after wars, with the notable exception of the end of the 19th century and the end of the 20th century. these increases have had contrasting consequences both in terms of macroeconomic consequences and in terms of the solutions implemented to reduce these debt bumps. a distinctive element between these 20th century episodes and those of the 18th and 19th centuries was the use of financial engineering to smooth out the debt jumps, making it possible to « buy the time » necessary, in any post-war period, to restore macroeconomic equilibrium.
This remarkable result did not prevent the debt-to-GDP ratio from increasing at a dizzying pace until 1815, in line with the wars with France.
Between 1688 (the Glorious Revolution) and the years 1730-1740, England succeeded in acquiring a considerable debt capacity. This financial revolution was the nerve of the wars that followed until 1815. It anticipated and prepared the industrial revolution, capitalist expansion and British domination. The debt and the debt/GDP ratio were to explode in the 18th century, the latter exceeding 250% in 1815. If there were financial shocks, the sterling and the credit of the state would hold and consolidate. The article shows how this was achieved: an increase in the capacity to raise taxes in connection with the parliamentary takeover, monetary reform accomplished in the crisis of 1694-97, the creation of the Bank of England to support the debt, the policy of transforming the debt into shares of a colonial company, hiving off and restructuring which gave rise to the major speculative drift of the South Sea Bubble.
The contrast between the 18th and 19th centuries is dramatic. After 1815, with British domination assured, priority was given to reducing levies; the amount of debt was reduced only belatedly and moderately. On the other hand, thanks to growth, the debt/GDP ratio will collapse. Until 1914.
The debt-to-GDP ratio falls, but the amount of debt is only reduced late and moderately.
In this article, we review the history of the French public debt during the long 19th century, from the consulate to the great war. We evaluate the importance of this debt and the main lines of its evolution by linking it to budget surpluses. Finally, we present the range of financial instruments used by the Fench government and the main methods of debt management.
After 1945, public debt was used to finance infrastructure spending which allowed the emergence of the mode of growth of the Golden Age whose dynamism and inflationary character then ensured the reduction. Since then, the drift of the public debt testifies to the tension between the imperative of redistribution in response to the new responsibilities of the State and the limits encountered by tax levies. In 2022, the search for an alternative growth model and a functional tax system has still not succeeded, so that public debt has become the structural adjustment variable. The repercussions of the 2008 financial crisis, then that of the Euro and finally the pandemic point in the same direction: the use of public debt in response to adverse events. In the trade-off between social peace through redistribution and preparation for the future, most governments have favored the first option. In the absence of a founding compromise of the type observed in social-democratic economies, capable of reconciling these two objectives, the drift in public finances appears as a means of continuing to buy time. Can it last forever?
Defining and Assessing Sustainability
The steady rise in Japanese public debt is regularly a concern. Its role in managing the macroeconomic equilibrium – preventing growth from being stifled by an excess of private saving – is more rarely stressed. As long as private agents continue to want to spend less than they earn and to accumulate debt claims, it is futile to hope for a rapid fall in Japan's public debt to GDP ratio. Still, the government faces a major challenge: being able to generate budget surpluses tomorrow if private agents decide to spend more than they earn by drawing on the deposits they have accumulated.
Unlike the concept of solvency, whose theoretical foundations are clear, the notion of sustainability calls for considerations on the political and social acceptability of public debt, considerations that are mostly left out of the analysis. This article highlights the limits of the notion of sustainability, pointing out the incentives of political leaders and questioning the representation of public debt as a burden.
Quantified analysis of public debt sustainability raises challenges that standard approaches don't solve. Debt Sustainability Analysis (DSA) as conducted par international institutions such as IMF or European Commission use too much convention and are insufficiently transparent. We propose a new definition of sustainability of public debt and a modelisation of public debt dynamic which allow to deal with the speculativeness needed for sustainability analysis. Public choices, e.g. fiscal or monetary policies, change radically the dynamic of public debt. Therefore, DSAs, by rooting those elements in past observations with a monetary or a fiscal rule, miss the point and fail to take in account all possible futures. With a model where fiscal policy is computed forward looking, in order to reach a public debt target in the medium term, different paths for the economy (inflation, long term growth, short term outcomes) can be considered and the difficulty to reach the public debt target can be quantified. Sustainability is thus the ability to accept difficult policies.
The purpose of this text is to show that the distinction between optimality and sustainability leads to the identification of a new paradox for the management of public debts, which is called the pseudo-paradox of Triffin. It is based on three observations. First, the status of safe assets or international store of value allows low real financing costs for the public debts of developed countries, even with inflation now high. Then, the international increase in demand for safe assets over the past twenty years has led to an increase in public debt to benefit from low interest rates in the face of new spending. Finally, the return of macroeconomic shocks can suddenly cause the status of safe assets to be lost. The paradox is based on the increase in optimal short-term debt and the decrease in sustainable long-term debt. We present this paradox and develop the implications for the European framework.
What Solutions to Ensure Sustainable Paths?
The very high level of public debt rates after the Covid crisis has revived the debate on the sustainability of public debt.
For some, it is urgent to return to a more restrictive fiscal policy, to reduce public debt rates, to avoid the divergence of public debt rates that would certainly lead to a financial crisis; for others, in an environment of very low interest rates, it is necessary, on the contrary, for the State to take on more debt in order to finance necessary public spending. Policy makers are confronted with this divergence of views among economists, which obviously makes their task difficult. We will try here to reflect on this question of public debt by organizing the reflection into seven points, and by illustrating the analysis with data for the euro zone.
The public debt is sustainable when the State can pay off its loans wih interests, possibly by reborrowing. To secure its creditors, the State should be able to stabilize the debt, as a percentage of the GDP, when the economic outlook is normal, and consequently to stabilize the public deficit although it is on a growing slope in France. To stabilize the deficit is more difficult when the average interest rate on sovereign debt is larger than the nominal growth rate of the GDP.
A stronger potential growth improves the public debt sustainability but it is cautious not to count on that. A higher inflation rate will not obviously reduce the public debt, as a percentage of the GDP, and its effects are negative on the long run. Tax and social contribution revenues can be increased but there is only a small margin to do it in France. Mutualizing public expenditures and debts at the european level is a good solution but it requires a solidarity between coutries that could lack. Controling the public expenditures growth remains a good solution but it could be insufficient in the french social and political current situation.
The Political Work of Creditworthiness: containment of the Covid Debt and Restoration of the Public Narrative Order
We analyze the political and institutional design of Covid debt treatment. During the pandemic, the importance of sovereign creditworthiness, whatever the macroeconomic and financial context, is reasserted. We show that the debt amortization mechanism (containment, cantonnement in French) – retained in a minimal version – responds to the objective of restoring order to the public debate: organizing credibility and confidence in the debt, evacuating the alternatives in order to maintain the advantage of the cultural battle over public finances (blaming excessive spending and social mismanagement as culprits) and preparing the return to « normal » of the separation between the monetary and fiscal domains. Metaphorically speaking, amortizing (and containing) the debt makes it possible to contain the overflow of public finance ratios, but also to stem the swarming of innovations (monetary, financial, fiscal) that were heard loudly in the public arena during the successive confinements. We show that « everything fits together » when it comes to sovereign creditworthiness: the material reality of investors and the financial community confidence (objectified by the risk premiums required at the time of lending) does not evolve independently of the political narratives that circulate in the public arena.
The financial crisis has contributed to setting up, in advanced countries, a new type of « policy mix » characterized by fiscal dominance. The health crisis has radicalized its forms and intensified its use. This article first proposes to describe how it works, then to analyze its limits. The return of inflation and a risk of financial instability have indeed led this regulatory system into a dead end. To get out of it, the best solution would certainly be to return to stronger and more sustainable growth. We then seek to define the directions to be taken and the means to be used to achieve this.
Sustainability in the European Budgetary Framework
Twenty years after the inception of EMU, a revision of its rules and, beyond that, of its economic coordination framework, is on the agenda. This article reviews some recent proposals claiming to deliver rules or « standards » that would be less complex and more flexible and would better fit the specificities of the Member States than the current rules. Conversely, this article puts forward a reform that would be based on a few simple criteria. The new arrangement would rest on numerical variables that would be enforceable and not manipulable. Its implementation would be easily monitored by the European authorities, whose prerogatives would be strengthened. The structural balance objective, which could be adapted to the level of debt of the Member States, would provide the cornerstone of the arrangement. However, creating a new set of common rules in an increasingly heterogenous economic area seems highly hypothetical without a strengthening of the European governance framework. Consequently, the current discussions on the fiscal framework should not ignore a more fundamental project: an overall reform of the economic policies of EMU. Of course, this presupposes a political will to proceed toward a less intergovernmental and more federal model.
The high levels of public debt are rekindling concerns about the unsustainability of public finances in some EU member states. The proposals for reforming the European budgetary framework take this dimension into account, but they struggle to link the discourse on the rules, even if modified or improved, with their European democratic legitimacy. The latter deserves to be discussed in order to ensure better appropriation of European rules by the member states.
In this interview, he traces the progress of European policy in the wake of the financial crisis and after the pandemic crisis and how this European policy has made it possible to absorb some of the debt of sovereign states and to stabilize the surge in European debt.
The objective of this article is to suggest an evolution of the regulation on the use of mobile money in order to improve its efficiency in the CEMAC sub-region. We show that this efficiency is based on the need for coordination of actions, the establishment of trust, the management of payment means and security. The new regulatory framework must therefore gradually migrate from an institutional approach to a more functional approach. We recognize that the expected gains will ensure the stability, reliability and integrity of the payment system, while promoting financial inclusion of the poor.
Financial History Chronicle
The concept of human capital has become critical for both the academic (economists, management scholars) and business communities. In the first part of our paper, we define the concept of human capital and present the different methodologies enabling its assessment. In the second part, we emphasize on human capital in private equity investment, shedding the light on business professionals' growing interest for human capital which represents a key asset for emerging firms especially in the service sector (banking, insurance, consulting, education) and high-tech industries.