The IMF released the analytical segment of its latest WEO (the full release occurs in the second week of October before the IMF-WB meetings). Two chapters (3&4), one focussing on the debt-overhang in advanced economies, the other on the 'resilience' of emerging markets and the link to economic policies. Chapter 3 offers a country-specific analysis of debt dynamics at certain threshold levels and is historically focussed (in line with the FAD's data compilation of over a century's worth of debt data). It deals with 'episodes' as related to the sustainability factor upon crossing thresholds. Naturally, the 100% mark is frequently used as:
"First, it is most relevant today given the number of countries currently close to or above that threshold. Second, 100 percent is high relative to historical experience: only 15 percent of the observations in our advanced economy database are above 100 percent. Third, our analysis suggests that political and economic forces do not tend to exert downward pressure on debt on average until public debt reaches this level."
Before picking on a few charts and conclusions, the basic framework of course is this:
Five variables - the stock of debt, the interest paid on this stock of debt, the inflation rate for the deflator, the real growth rate and the primary balance (ratio of GDP). So essentially -
d(t)= ((1+i)/(1+pi)(1+g) )*d(t-1) + pb + e
where d(t) and d(t-1) is the stock of debt at time t. i is the interest paid on the stock of debt. pi is the inflation rate for the deflator, g is the real growth rate, pb is the primary balance ratio and e is the residual which accounts for accounting valuation differences and adjustments.
For Japan, I'll try and incorporate the fiscal balance, debt, real growth and inflation into one and the bond yields and policy rate into another. Here's what they look like:
Good historical perspective on the 'liquidity trap'. The second graph shows the low borrowing costs the government has had for over a decade. This 'over-a-decade' time frame is also one characterized by the zero-bound. Japan's debt progression has been steady and unhindered (most of the debt is public). You can see two episodes of the deflationary spiral in the 90's as well as a steady stream of persistently higher fiscal deficits. What's interesting is the brief period pre-crisis when the debt dynamics stabilize accompanied by consistent 2% growth and a much-needed increase in price levels as well as a severe reduction in the deficit before slipping into recession again.
The most interesting data comes from the actual decomposition of the debt dynamics. That is, categorizing by time-period. what percent of GDP each debt-dynamic factor contributed to the change in debt. This is what it looks like:
Only in the '02-'07 period does growth contribute significantly to the change in debt whereas inflation has a minimal contribution during the same time frame. The consistency in the interest rates across such a long period of time is reflected in the lack of change in contribution. The '02-'07 period incidentally, is the period characterized by literally zero interest rates and low borrowing costs.
I suppose 1997 could be somewhat of a midpoint for the 'lost decade'. It's the point where Japan's debt-to-GDP ratio touched the 100% threshold and the country found itself mired in a mild deflation trap with stagnant output levels - significant repercussions of the devastating aftermath of the real estate and stock market bubble bursts. What followed immediately was near-panic monetary policy and fiscal stimulus, evidenced by a severe deterioration in the fiscal balance. The problem was that the slashing of interest rates was overshadowed by the accompanying drastically low levels of inflation and inflation expectations (The Japanese REER appreciated 60% in the early 90's!), that gives you a sense of what happened to the nominal effective rate at those inflation levels!
The WEO says that "This episode highlights the need to deal with banking sector weakness and ensure a supportive monetary environment before fiscal consolidation can succeed."
Furthermore, "When structural weakness in the financial system prevents the normal transmission of monetary stimulus and when policy rates are constrained by the zero lower bound, the risk of anemic and fragile growth is high regardless of the fiscal setting."
There's a lot of truth, intuition as well as evidence behind that supposition.
"First, it is most relevant today given the number of countries currently close to or above that threshold. Second, 100 percent is high relative to historical experience: only 15 percent of the observations in our advanced economy database are above 100 percent. Third, our analysis suggests that political and economic forces do not tend to exert downward pressure on debt on average until public debt reaches this level."
Before picking on a few charts and conclusions, the basic framework of course is this:
Five variables - the stock of debt, the interest paid on this stock of debt, the inflation rate for the deflator, the real growth rate and the primary balance (ratio of GDP). So essentially -
d(t)= ((1+i)/(1+pi)(1+g) )*d(t-1) + pb + e
where d(t) and d(t-1) is the stock of debt at time t. i is the interest paid on the stock of debt. pi is the inflation rate for the deflator, g is the real growth rate, pb is the primary balance ratio and e is the residual which accounts for accounting valuation differences and adjustments.
For Japan, I'll try and incorporate the fiscal balance, debt, real growth and inflation into one and the bond yields and policy rate into another. Here's what they look like:
Good historical perspective on the 'liquidity trap'. The second graph shows the low borrowing costs the government has had for over a decade. This 'over-a-decade' time frame is also one characterized by the zero-bound. Japan's debt progression has been steady and unhindered (most of the debt is public). You can see two episodes of the deflationary spiral in the 90's as well as a steady stream of persistently higher fiscal deficits. What's interesting is the brief period pre-crisis when the debt dynamics stabilize accompanied by consistent 2% growth and a much-needed increase in price levels as well as a severe reduction in the deficit before slipping into recession again.
The most interesting data comes from the actual decomposition of the debt dynamics. That is, categorizing by time-period. what percent of GDP each debt-dynamic factor contributed to the change in debt. This is what it looks like:
Only in the '02-'07 period does growth contribute significantly to the change in debt whereas inflation has a minimal contribution during the same time frame. The consistency in the interest rates across such a long period of time is reflected in the lack of change in contribution. The '02-'07 period incidentally, is the period characterized by literally zero interest rates and low borrowing costs.
I suppose 1997 could be somewhat of a midpoint for the 'lost decade'. It's the point where Japan's debt-to-GDP ratio touched the 100% threshold and the country found itself mired in a mild deflation trap with stagnant output levels - significant repercussions of the devastating aftermath of the real estate and stock market bubble bursts. What followed immediately was near-panic monetary policy and fiscal stimulus, evidenced by a severe deterioration in the fiscal balance. The problem was that the slashing of interest rates was overshadowed by the accompanying drastically low levels of inflation and inflation expectations (The Japanese REER appreciated 60% in the early 90's!), that gives you a sense of what happened to the nominal effective rate at those inflation levels!
The WEO says that "This episode highlights the need to deal with banking sector weakness and ensure a supportive monetary environment before fiscal consolidation can succeed."
Furthermore, "When structural weakness in the financial system prevents the normal transmission of monetary stimulus and when policy rates are constrained by the zero lower bound, the risk of anemic and fragile growth is high regardless of the fiscal setting."
There's a lot of truth, intuition as well as evidence behind that supposition.
No comments:
Post a Comment