The chapter investigates the potential impact of overall debt and sectoral indebtedness (i.e. households, non-financial corporations, government, private and external) on economic growth. To this end, two quantitative approaches are employed. First, a multivariate panel logit model with fixed effects is used to assess the response of the recession probability to various threshold values of debt across several emerging European economies. Secondly, an asset pricing model is also applied in order to cross-check the regression results. The study takes a macroprudential perspective, by looking for solutions to reach the intermediate macroprudential objective of preventing excessive indebtedness. One important conclusion the results bring forward is that ‘one size fits all’ type of measures or thresholds might not be the optimal solution, as countries can bear various debt levels. Similarly, the different sectors investigated in this chapter proved to have a contrasting resilience to different debt values.
Liviu Voinea, Alexie Alupoaiei, Florin Dragu and Florian Neagu
Giuseppe Eusepi and Richard E. Wagner
Antonio de Viti de Marco, accepted David Ricardo’s proposition that an extraordinary tax and a public loan are equivalent. All the same, de Viti’s theory of public debt diverged sharply from Ricardo’s. Ricardo thought effectively in representative agent terms; De Viti did not, and thought instead of macro variables as emerging out of interaction among individuals. Ricardo’s macro framework entailed the self-extinction of public debt due to its representative agent quality. In contrast, de Viti’s micro framework explained that self-extinction depended on the operating properties of the political system in which public debt was generated. Within the theoretical extremum of a system of cooperative democracy, self-extinction was a likely property. Ordinary democratic systems, however, featured continuing competition among elites striving for power. This competition enabled politically dominant groups to pass cost onto others in society, bringing about a de facto form of debt default and not self-extinction.
Edited by Giuseppe Eusepi and Richard E. Wagner
Richard E. Wagner
Personal debts are obligations that people establish through agreement among one another, so it is easy to understand the general objection to defaulting on personal debts. Can such objections be reasonably extended to public debts within democratic regimes? Much depends on how reasonable it is to characterize democracy as a genuine system of self-governance, as against being a system where relationships of domination and subordination are masked by ideological claims on behalf of self-governance. Democratic governance always rests with a subset of the population. To be sure, it is conceivable, though not necessary, that governance could nonetheless proceed in a generally consensual fashion. Debt default is always a latent possibility that depends on momentary patterns of political coalition.
Fabrizio Balassone, Sara Cecchetti, Martina Cecioni, Marika Cioffi, Wanda Cornacchia, Flavia Corneli and Gabriele Semeraro
The unchecked build-up of imbalances during the 2000s exposed the euro area to the risk of sudden stops. Such risk materialized in 2009–10 and its consequences were amplified by the absence of adequate institutions. Europe embarked on a thorough process of reforming its economic governance. We review the measures taken concerning sovereigns and banks since 2010 and discuss possible ways forward on both fronts. We argue that, while significant progress has been achieved, a lot of ground remains to be covered. In general, reforms have favoured risk reduction over risk sharing. As a result, in the face of exceptional circumstances, the euro area is not equipped with the fiscal tools necessary for macroeconomic stabilization; moreover, banking union lacks common financial backstops. Only further risk (and sovereignty) sharing can avoid harmful pro-cyclical excesses.
There is a public debate and large body of politico-economic literature discussing the design of fiscal rules and other instruments of fiscal governance assumed to prevent solvency problems and bailouts of countries. Essentially and implicitly, this literature discusses the issue of how to regulate the ‘demand side’ of the ‘market’ for sovereign bailouts. This chapter complements this strand of research by discussing the possibilities and limitations of regulating the ‘supply side’ of this market (namely, governments, central banks, and international organizations in their role as potential rescuers). Thinking about the governance of this market makes sense because well-intentioned sovereign bailouts may have serious side-effects, such as the ‘moral hazard problem’ and the ‘soft budget constraint problem’. Finally, it is discussed whether the citizens of potential ‘rescuer-jurisdictions’ should get the opportunity to vote in a binding referendum on whether ‘to bail out, or not to bail out?’
Ernesto Longobardi and Antonio Pedone
This chapter deals with the issue of sovereign debts in the Eurozone. After a brief discussion of the reasons for their reduction, the different strategies used in the past to this end are considered. It is argued that they are either not viable today or can assure only limited results. Thus, the policy of accumulating primary surpluses seems the only practicable one. However, the alternative of restructuring has been investigated with growing attention. Two distinct perspectives have been followed. On one side, a number of proposals deal with the issue of existing debt. There are reasons to doubt that they are substantially different from the policies currently followed. On the other side, several projects are aimed at establishing a permanent insolvency mechanism for sovereigns, with the purpose of making effective the no bail-out principle. The question is raised as to whether they are feasible in the absence of any element of fiscal union.
Andrea Rieck and Ludger Schuknecht
Unhealthy and potentially unsustainable debt dynamics have been affecting advanced as well as developing economies. In this chapter we take stock of government obligations and private debt that could migrate to public balance sheets. We analyse different approaches to dealing with debt overhangs which have been pursued at various times. Building on past experiences, we discuss institutional mechanisms to achieve and preserve debt sustainability. Strong rules and institutions, clear accountability and credible enforcement procedures are essential to regain fiscal discipline and avert a potential future systemic fiscal crisis. We reject implicit or outright default as an acceptable way out of debt. Instead, we advocate strengthening national and international institutional underpinnings in order to ensure that contracting parties are able and willing to serve the commitments they have made.
The very existence of public debt presupposes an ethical commitment by current governments to fulfil the undertakings of predecessors – or at least a belief among potential bondholders that such a commitment exists. This commitment should not be confused with electoral ‘promises’, which serve a different (weak signalling) function: the ‘political obligations’ associated with public debt are stronger than those associated with electoral promises. There is, moreover, an ethical dimension to electoral behaviour: individual voters’ ethical commitments play a role in their choosing how to vote – a more significant role than ethical commitments play in market choices. This ethical dimension may conceivably overcome the interest-based incentive nations have in free-riding on global climate deals. But that is more likely to be so if emission-reduction policies are financed out of public debt. However, debt-financing is a disappearing option, because in most countries debt is at levels that are inhospitable to further increase.