This is my translation of a Commentary on Current Affairs written by François Ecalle on the French blog Fipeco, devoted to analyses of public finance and the economy in France. Ecalle begins here his discussion of how one might understand public debt, and whether or not it ought to be limited. This is the first part of my translation of Ecalle’s article.
My thanks to François Ecalle for permission to publish this translation on my blog.
French article by François Ecalle
English translation by Urmila Nair.
Date of publication: November 11, 2020.
To view the original French article, click HERE
The Translation, part I
France’s debt-to-GDP ratio will have increased sharply by the end of 2020, and will probably increase further over the coming years (cf. my article dated October 14, 2020)1. In this context, many French people are wondering if there are limits to public debt that must not be exceeded. This article sheds light on this question: we begin with an overview of the ‘classical’ analysis of the sustainability of public debt2, and then examine in what way it needs to be amended to take into account low interest rates, the fact that a large part of the public debt is held by the central bank, and the specificities of the euro area.
It is impossible to determine a threshold of debt beyond which a crisis of public finance would be triggered, necessitating the imposition of drastic recovery measures. This is because such an event depends on numerous parameters that are often not quantifiable, and that are specific to country and conjuncture. To avoid such a crisis, the debt-to-GDP ratio needs to be stabilized, at whatever level. This is a necessary condition for public debt sustainability. However, it is not a sufficient condition since the level to which this ratio, and thus public debt, are stabilized is not insignificant: the higher the debt, the greater the risk of a crisis.
If the apparent interest rate on public debt3 is greater than the nominal GDP growth rate—the typical hypothesis of the classical analysis of debt sustainability—then, in order to stabilize this debt, the primary surplus (that is, the surplus excluding interest expenditures) must equal a ‘stabilizing’ surplus, which increases with increase in debt. If public debt is necessary, such as in troubled times, it has to be reduced when times are good, so as to avoid having to generate an unattainable primary surplus to stabilize debt.
If the apparent interest rate is lower than the nominal GDP growth rate—a situation which may obtain over a long period—maintaining a primary deficit at a certain level, whatever that level may be, would always enable debt stabilization. The debt would, therefore, always be sustainable. Nevertheless, it could in this manner be stabilized to such a high level that a crisis is likely long before that level is attained. Furthermore, the difference between apparent interest rate and nominal GDP growth rate could turn positive in the more or less long term.
Above all, no matter what the interest rate, a continuous increase of debt-to-GDP ratio entails a debt on an ever-upward trajectory. So, tax laws staying the same, the growth of public expenditure should be less than or equal to that of GDP to avoid a deficit increase. If the growth in expenditure remains greater than that of GDP, an increase in taxes could stabilize debt only if it were repeated indefinitely.
In case of France, if potential growth4 is stable at 1.0% after the end of the crisis, then the real growth of public expenditure would have to be at most 1.0% per annum. However, it was only reduced with great difficulty to 1.1% from 2011 to 2019, with a view to containing the deficit and to avoiding placing public debt on an ever-upward trajectory.
Central banks are able to grant favorable financing conditions to States so long as inflation does not pick up. While the current outlook for inflation evolution is uncertain, its return cannot be ruled out, especially if public deficit increases continuously5. A low degree of inflation could initially facilitate control of the debt trajectory. However, the return of inflation could also bring with it risks. Central banks would then have to increase interest rates and reduce the financing of States. The latter would then be increasingly exposed to market assessments of their fundamentals and would find themselves in a situation made that much more difficult by the fact that their debt had increased.
The euro area manifests the following peculiarities: legal rules aimed at avoiding excessive public debt and deficit; a European Union borrowing capacity that is very limited following the European Council of July 2020; an ECB intervention capacity in support of States that is unlimited only under strict conditions.
All in all, there is not precise limit. A State cannot indebt itself indefinitely and takes risks by further indebting itself. To reduce these risks, once the current crisis ends, it will be necessary to maintain the growth of public expenditure at a level below that of potential GDP.
To be continued in On the limits of public debt, Part II
Translator’s note: Ecalle’s article is dated November 18, 2020. ↩︎
Translator’s explanatory note on the ‘classical’ analysis of public debt sustainability:
Elsewhere on his website, Ecalle explains the ‘classical’ analysis of public debt sustainability . He writes there (my translation):
“According to the oldest and most frequently used approach, the situation of public finances is sustainable if the debt-to-GDP ratio is stable within an infinite horizon, economic policy remaining unchanged, irrespective of the level to which this ratio is stabilized [or made to converge]. Under relatively unconstraining assumptions, future revenues then cover current debt and future expenditure.”
The study Ecalle cites is that of Blanchard et al 1990, who write:
“Fiscal policy can be thought of as a set of rules, as well as an inherited level of debt. And a sustainable fiscal policy can be defined as a policy such that the ratio of debt to GNP eventually converges back to its initial level ... for a fiscal policy to be sustainable, a government which has debt outstanding must anticipate sooner or later to run primary budget surpluses.” (Blanchard, Olivier et al. “The sustainability of fiscal policy: new answers to an old question,” OECD Economic Studies No. 15, Autumn 1990: 11) ↩︎
On translating “taux d’intérêt apparent de la dette publique” as “apparent interest rate on public debt”:
In French, the following was among the explanations found for the term taux d’intérêt apparent de la dette publique:
“Le taux apparent de la dette publique d’une année est le rapport entre la charge d’intérêt constatée cette année-là et le montant de la dette à la fin de l’année précédente. Il dépend du taux auquel les emprunts de l’année en cours sont émis mais aussi des taux de tous les emprunts émis au cours des années antérieures et qui n’ont pas encore été totalement remboursés. En conséquence, l’impact d’une baisse des taux d’intérêt des nouveaux emprunts sur la charge d’intérêt de la dette est très progressif.” (page 7).
The term charge de la dette is explained as:
“La charge de la dette est l’ensemble des dépenses de l’État consacrées au paiement des intérêts de sa dette.”
In English, the term “apparent interest rate” was found with a similar definition and formula, though its use in macroeconomic contexts was only attested in documents and studies by several French entities: in a policy paper on Italy’s debt published by the French research institute Observatoire français des conjonctures économiques (OFCE) or French Economic Observatory; in an article published by the Banque de France on macroeconomic projections for France. The term is also attested in microeconomic contexts: for example, in several research articles by French researchers; and in opposition to real interest rates in one Oxford University Press textbook (“apparent” here corresponds to the more commonly encountered nominal).
The English term “apparent interest rate” is therefore used provisionally here in the macroeconomic context: further detective work would be required to unearth whether it is indeed a standard term in macroeconomic contexts.
The explanation of the term apparent interest rate in the Banque de France document is as follows:
“the apparent interest rate on government debt … measures the amount of interest paid as a share of total outstanding debt” (page 7). ↩︎
Translator’s explanatory note on “potential growth” which translates “croissance potentielle”:
The following was among the explanations found for the term “croissance potentielle”:
“En macroéconomie, la croissance potentielle est une estimation du taux de croissance du PIB (Produit intérieur brut) lorsque les facteurs de production (travail, capital) sont utilisés de manière optimale, en l’absence de tension sur le marché des biens et services et sur celui du travail (c’est-à-dire avec une inflation stable). Elle résulte d’une modélisation de l’économie, basée sur une estimation de l’évolution de la quantité de travail disponible, de l’évolution du capital disponible et des gains de productivité réalisés par les entreprises (“productivité globale des facteurs”), souvent assimilés au progrès technique.”
The English equivalent is “potential growth”:
“Potential growth is the rate of growth that an economy can sustain over the medium term without generating excess inflation. … The output gap – the difference between actual output and potential output – is a key indicator of inflationary pressures.”
This relates to the notion of “potential GDP”:
“Potential gross domestic product (GDP) is defined in the OECD’s Economic Outlook publication as the level of output that an economy can produce at a constant inflation rate. Although an economy can temporarily produce more than its potential level of output, that comes at the cost of rising inflation. Potential output depends on the capital stock, the potential labour force (which depends on demographic factors and on participation rates), the non-accelerating inflation rate of unemployment (NAIRU), and the level of labour efficiency.” ↩︎
Translator’s note: Once more, Ecalle’s article appeared in November 2021. See this Le Monde article on current speculation about inflation in France and Europe. ↩︎