Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics
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Finance Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics THE PUBLIC DEBT AS A GLOBAL PROBLEM
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Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics. THE PUBLIC DEBT AS A GLOBAL PROBLEM. Lecture outline. Increasing debt levels in the world Debt crisis - definition and mechanism The case of the euro area sovereign debt crisis. Government debt to GDP in the world. - PowerPoint PPT Presentation
Transcript of Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics
Finance 110631-1165
Dr Katarzyna SumChair of International FinanceWarsaw School of Economics
THE PUBLIC DEBT AS A GLOBAL PROBLEM
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Lecture outline
Increasing debt levels in the world
Debt crisis- definition and mechanism
The case of the euro area sovereign debt
crisis
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Government debt to GDP in the world
Source: Wikipedia.
The Polish public debt clock
Source:www.for.org.plFinance 110631-1165
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Government bonds
National government bonds- issued in domestic currency
Sovereign bonds- issued in foreign currency
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Government bonds
Low risk premium of government bonds: Governments are able to undertake policy
measures to pay off their debt (taxes, expenses)
The risk premium depends on the credibility of the government
Sovereign bonds – additional risk related to exchange rate movements and availability of foreign currency
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Problems related to public debt accummulation
Decreasing credibility Increasing risk premia
Investors start demanding a much higher compensation
for the risk of holding the increasingly large amounts of
public debt that authorities are going to issue
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Accummulation of public debt globally
Individual country factors
Global factors-
the financial crisis from 2007-2009,
Global unequilibrium
Accummulation of public debt globally
The need to recapitalize banks after the crisisGovernments had to take over a large part of the debts of failing
financial institutionsThe introduction of large stimulus programmes to revive demand Prospects of further debt increase due to demographic tendencies
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Accummulation of public debt globally
Total industrialised country public sector
debt is exceeded 100% of GDP in 2011!!!
(OECD)
Strong deterioration in countries which
had a balanced situation before the crisis
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Further development will depend on:
The ultimate costs of the financial crisis
The rate of real growth
The level of interest rates,
Political decisions about spending and taxes
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Short term and long term spending
Short term- to mitigate the effects of the
financial crisis
Long term- to deal with the ageing of societies
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Unfunded liabilities arising from ageing
The pension system is based on the pay-as you
go method
This means that current pensions has to be
financed by current contributions
Ageing of the population creates the need of
additional borrowing
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Age related government expenditure
Source: Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, The future of public debt: prospects and implications, BIS Working Paper 2010.
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Prospects
Source: Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, The future of public debt: prospects and implications, BIS Working Paper 2010
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Debt crisis
A situation of excessive government debt
accummulation which renders an economy
incapable of paying off its debt without the help
of third parties
A type of financial crisis
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Debt crisis
Initially high level of public debt creates the risk
of unstable debt dynamics
Increasing risk premia
Lower long term growth due the higher cost of
servicing the debt
What happens to bond yields during the debt crisis?
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Source: Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial markets, BIS Quarterly Review, December 2011
What triggered the sovereign debt crisis in the Eurozone?
The performance of respective Eurozone countries
Excessive lending, asset price bubbles
and a loss of competitiveness Overheating combined with structural
problems PIIGS
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Did the euro zone try to prevnet the debt crisis?
The Stability and Growth Pact Aimed at
preventing excessive deficits and public debt
The no-bail out principle- the respective euro
area member states are not liable for the debt of
other member states
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• Source: Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial markets, BIS Quarterly Review, December 2011
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The preventive measures
undertaken were not sufficient!
Even before the financial crisis countries did not
comply with the Pact reqirements
The situation worsened when the governments
had to fight the consequences of the crisis
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The reaction of the financial markets
High volatility of equity and bond markets
Downgrades of country ratings exerted
additional upward pressure on government
bond yields
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The reaction of the financial markets
The financial markets demanded higher
risk premia- financing contsraint
Additionaly- bank funding problems
This created the need of policy measures
to restore confidence
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Political measures
Debt remission for Greece
Leveraging of the European Financial Stability
Facility
Recapitalisation of banks
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Political measures
The political measures undertaken
contradict the no-bailout clause
The need of redefining the fiscal rules of
the eurozone
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Securities Markets Programme
Interventions by the Eurosystem in public and
private debt securities markets in the euro area
to ensure depth and liquidity
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Securities Markets Programme
Source: Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial markets, BIS Quarterly Review, December 2011
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Global spillovers
After the decrease of the euro area soveriegn
debt and bank debt the financial institutions
which held the securities were exposed to
increased costs
This affected institutions globally
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Debt crisis resolution
In the past debt crises were resolved by:
Economic growth
Substantive fiscal adjustment/austerity plans;
Explicit default or restructuring of private and/or
public debt;
A sudden surprise burst in inflation
Financial repression
Financial repression
„Directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements„
Source:Carmen M. Reinhart, M. Belen Sbrancia, The Liquidation of Government Debt, BIS Working Papers 2011
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Debt crisis resolution
The resolution of the euro area sovereign debt crisis should consider:
Changing economic conditions Demographical tendencies
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Summing up
Governments can borrow financial resources by
means of issuing bonds
Bonds can be issued in national currency
(national bonds) or foreign currency (sovereign
bonds)
Usually governments bonds are regarded as risk
free securities
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Summing up
The excessive accummulation of debt
leads to an increase of risk premia and
increases to costs of debt servicing
A debt crisis occurs if a country can jot
repay its debt without the help of a third
party
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Literature
Source: Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, The future of public debt: prospects and implications, BIS Working Paper 2010
Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial markets, BIS Quarterly Review, December 2011
Carmen M. Reinhart, M. Belen Sbrancia, The Liquidation of Government Debt, BIS Working Papers 2011
