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Assessing debt sustainability

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Presentation by Agnès Bénassy-Quéré, Professor, University Paris 1 Panthéon-Sorbonne and Paris School of Economics
Conference on:
“Sovereign Debt Crises: Prevention and Management"
Rome, 10 December 2018

Published in: Economy & Finance
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Assessing debt sustainability

  1. 1. Assessing debt sustainability Agnès Bénassy-Quéré Sovereign debt Crises: Prevention and Management, Rome, 10 December 2018
  2. 2. Who’s safe? Gross government debt, % of GDP Source: Ameco.
  3. 3. Who’s safe? (ctd) Government deficit, % of GDP Source: Ameco.
  4. 4. Factors influencing debt sustainability Macro factors  r-g over a very long period  Optimal debt level Willingness to pay  Tax pressure, tax evasion, efficiency of the public sector, perceived equity  Debt ownership Currency  Foreign currency debt more likely to be restructured, other things equal  Domestic currency: risk of monetization? Off-balance sheet liabilities  Ageing  Too-big-to-fail banks Government assets (?) Liquidity  Debt level + average maturity  Gross financing needs
  5. 5. Ageing and health care Source: IMF, Fiscal Monitor, April 2018.
  6. 6. Deficit and gross financing needs, 2018 Source: IMF, Fiscal Monitor, April 2018.
  7. 7. The tax sustainability gap Blanchard (1990), Blanchard et al. (1990)  Sustainable tax rate (𝜏∗ ): total tax rate consistent with stable debt ratio  Tax gap: 𝜏∗ − 𝜏 (alternatively: primary balance gap) Bénassy-Quéré and Roussellet (ITPF 2014)  Tax gaps for EU countries at the 4 and 50-year horizons  Impact of ageing and of r-g  Comparison with IMF (<60%, 10 years), EC (S2 – stable debt/GDP, 50 years) and rating agencies  Impact of TBTS banks
  8. 8. Impact of TBTF banks Methodology  EBA (2011): Consolidated RWA-core tier 1 under stress scenario  potential bailout cost  fixed cost in % of GDP over next 4 years  Binominal tree that stops in case of crisis (no more crisis after)  Yearly probability between 0 and 10%  annualized expected cost for the government  Alternatively: V-lab (Acharya et al. 2010), or econometric estimations for 60 systemic banking crisis over 1977-2010 (Reinhart&Rogoff 2010; Laeven&Valencia 2008, 2010 databases)  Unconditional probability: 2.78%, average fiscal cost 14.3% of GDP  Expected cost as a function of explanatory variables over the next 4 years.
  9. 9. Results (RWA)
  10. 10. Results (macro)
  11. 11. Conclusion: how to improve on debt sustainability Fiscal factors • Primary surplus (ambiguous) • Pension reforms Macro factors • Long-term growth • Interest rates (multiple equilibria) • Borrowing needs of the private sector Political factors • Government efficiency, perceived equity Banking factors • Capital requirements, bail-in rules • Doom loop (ambiguous)

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