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π Economics

Public debt: reduce or write off?

Patrick Artus
Head Economist at Natixis

Since the Covid cri­sis, pub­lic debt lev­els have been extreme­ly high (116% of GDP at the end of 2021 in France, for exam­ple). As such, it has reignit­ed the debate on the risks asso­ci­at­ed with such a lev­el of debt, giv­ing rise to very spec­trum of opin­ions. For some, it is inevitable that we are head­ing for a sov­er­eign debt cri­sis giv­en the high lev­el of debt and the pre­dict­ed rise in inter­est rates. Where­as for oth­ers we should fur­ther increase our debt whilst inter­est rates are low to finance nec­es­sary invest­ments – par­tic­u­lar­ly the ener­gy transition.

More­over, anoth­er ele­ment has emerged: a sig­nif­i­cant slice of pub­lic debt is now held by cen­tral banks and is thus record­ed on the lia­bil­i­ties side of these insti­tu­tions’ bal­ance sheets. There­fore, should it sim­ply be writ­ten off as some econ­o­mists have suggested?

Issuing new “Covid money”

Let us start with an analy­sis of this issue. Legal­ly, a cen­tral bank is part of the State (a 100% sub­sidiary, in fact). As such, it pays all its prof­its to the State so to get a bet­ter pic­ture we need to analyse the con­sol­i­dat­ed bal­ance sheet between the State and cen­tral bank. On the lia­bil­i­ties side, we find the part of the debt that is not held by the cen­tral bank and the mon­ey recent­ly print­ed by the cen­tral bank to buy back finan­cial assets (main­ly in the form of pub­lic sec­tor bonds). On the oth­er hand, the part of the pub­lic debt held by the cen­tral bank does not appear, since it is a claim of the State on itself, which there­fore does not exist.

As a con­se­quence, the pub­lic debt left over can be con­sid­ered that which is not held by the cen­tral bank. In the case of France, for exam­ple, it is 90% of GDP – the same lev­el as before the Covid cri­sis. So, there would be no need to can­cel pub­lic debt held by the cen­tral bank because there is no Covid debt. What we have is Covid mon­ey, which was issued by cen­tral bankers to finance asset pur­chas­es. For me, the reflec­tion should there­fore be on the con­se­quences of mas­sive mon­ey cre­ation dur­ing the cri­sis – finan­cial insta­bil­i­ty, exces­sive rise in stock prices and infla­tion in prop­er­ty prices – and not on the con­se­quences of the exis­tence of Covid debt.

Rising public debt

Pub­lic debt lev­els before Covid were already very high. More­over, it is now clear that many expen­di­tures will have to be increased in the long-term. This is the case for cer­tain sec­tors in France as it is in all OECD coun­tries: rein­dus­tri­al­i­sa­tion, train­ing, edu­ca­tion, health, secu­ri­ty, ener­gy tran­si­tion, and inno­va­tion. The spon­ta­neous trend would there­fore be to con­tin­ue to increase pub­lic spend­ing, main­tain high pub­lic deficits and con­tin­ue to increase the pub­lic debt ratio.

Some econ­o­mists do not see any obsta­cles to this devel­op­ment, argu­ing that low inter­est rates should be used to finance use­ful expen­di­ture such as the ener­gy tran­si­tion. How­ev­er, cer­tain con­straints will return and restrict expan­sion­ary fis­cal poli­cies. Let us take the case of France as an exam­ple. First of all, an insti­tu­tion­al con­straint: Europe will even­tu­al­ly put bud­getary rules back in place. These rules will cer­tain­ly be more flex­i­ble than before, allow­ing, for exam­ple, debt financ­ing of expen­di­ture linked to the ener­gy tran­si­tion. But these rules will prob­a­bly not allow all the pub­lic spend­ing envis­aged above to be possible.

Sec­ond­ly, a finan­cial con­straint. Today, long-term inter­est rates are much low­er than the long-term growth rate of the econ­o­my. For France today the 10-year inter­est rate is 0.2% whilst nom­i­nal long-term growth, in val­ue terms, is around 3%. The gap is there­fore con­sid­er­able, which allows for high­er pub­lic deficits as the pub­lic debt ratio spon­ta­neous­ly falls. But the time will come when the ECB will reduce its bond pur­chas­es, because the euro­zone econ­o­my will approach full employ­ment and because rapid mon­ey cre­ation will lead to an unsus­tain­able rise in prop­er­ty prices. The exit of the cen­tral bank from its pur­chase pro­gramme will inevitably lead to a rise in long-term inter­est rates, result­ing in a con­fig­u­ra­tion where the sta­bil­i­sa­tion of the pub­lic debt ratio will require a greater effort to reduce the pri­ma­ry pub­lic deficit (exclud­ing inter­est on the pub­lic debt).

Which policies are possible?

The above shows that in Europe, in the future, there will be a return to a bud­getary con­straint, with the need to reduce the pub­lic deficit. In France, it will fall from 8.4% of GDP in 2021 to 5% in 2022, but about half of this improve­ment comes from the end of the Covid cri­sis; this will no longer be the case in the future. What then are the pol­i­cy options? A tax increase is pos­si­ble, and indeed envis­aged, in coun­tries with a low tax bur­den (Unit­ed States, Unit­ed King­dom), but dif­fi­cult to imag­ine in France where tax­a­tion is among the high­est in the world.

In the case of France, a reform that sig­nif­i­cant­ly reduces pub­lic pen­sion expen­di­ture – near­ly 14% of GDP in France com­pared to 8% in oth­er euro­zone coun­tries – would pro­vide the nec­es­sary bud­getary lee­way. But we should not under­es­ti­mate the resis­tance of pub­lic opin­ion to such a reform. There is then one last avenue, which is to improve the effi­cien­cy of the state in coun­tries where it is questionable.

When we com­pare the OECD coun­tries, we see that France is around the aver­age for the qual­i­ty of pub­lic ser­vices: health, edu­ca­tion, jus­tice, secu­ri­ty, labour mar­ket. But the lev­el of pub­lic spend­ing is very high, even exclud­ing pen­sion spend­ing. If France had a nor­mal effi­cien­cy (pro­duc­tiv­i­ty) of the State com­pared to oth­er coun­tries, it could pro­vide pub­lic ser­vices of the same qual­i­ty at a cost of 7 points of GDP less. It is there­fore nec­es­sary to reopen the issue of state effi­cien­cy and pro­duc­tiv­i­ty, bear­ing in mind that, despite all the debates and com­mis­sions on this sub­ject, no progress has been made

A debt crisis?

In the end, we can see that the bud­getary con­straint will return, and that pub­lic deficits will have to be reduced where­as the spon­ta­neous ten­den­cy would be to main­tain or increase them. None of the three pos­si­ble avenues – increas­ing tax­es, reform­ing pen­sion or increas­ing the pro­duc­tiv­i­ty of the state – is easy to imple­ment. But if they are not imple­ment­ed, the choice is between allow­ing a debt cri­sis to take hold or not increas­ing the use­ful and effi­cient part of pub­lic spending.



Patrick Artus

Head Economist at Natixis

A graduate of Ecole Polytechnique, Ecole Nationale de la Statistique et de l'Administration Economique and the Institut d'Etudes Politiques de Paris, Patrick Artus was Director of Research and Studies at NATIXIS until 2020, then Chief Economist and Member of the Executive Committee. He combines his teaching duties with his research work and is associated with various economic journals and associations. Today Patrick Artus is on Boards of Directors at Total and IPSOS as a Director and Economic Advisor to Natixis.

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