Debt sustainability

Would Italy be better off without the euro?

With Sunday’s election of President Emmanuel Macron, voters confirmed that France remains a bedrock of the euro area, buttressing the region’s financial markets. But political risks to the euro have not disappeared. In coming months, concerns probably will turn to Italy, where the leader of one popular party has called for a referendum on leaving the euro area, and where parliamentary elections must be held before 20 May 2018.

From an economic perspective, Italy stands on a knife-edge. The economy is smaller and less productive than it was in 2001, while government debt has jumped by 30 percent. As long as interest rates remain low, and the government continues to run a primary budget surplus, the situation is only mildly unsustainable (with the debt/GDP ratio creeping higher). But even a small problem at home or abroad could drive funding costs higher and expose Italy’s precarious state.

Would independent Italian monetary policy, controlled by the Banca d’Italia in Rome, be sufficient to bring Italy back from the precipice and promote economic growth? We doubt it. In the long run, the most effective way to ensure debt sustainability is to implement growth-enhancing structural reforms. Nothing about Italy’s membership in the monetary union prevents this. The problem is a lack of political will...

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GDP-linked Bonds: A Primer

Gross government debt in advanced economies has surpassed 105% of GDP, up from less than 75% a decade ago. Some countries with especially large debts—including Greece (177%), Italy (133%) and Portugal (129%)—are viewed not only as a risk to the countries themselves, but to others as well. As a result, policymakers and economists have been looking for ways to make it easier to manage these heavier debt burdens.

One prominent suggestion is that countries should issue GDP-linked bonds that tie the size of debt payments to their economy's well-being. We find this idea attractive, and see the expanding discussion of the viability of GDP-linked bonds both warranted and useful (see here and here). However, the practical issues associated with GDP data revision remain a formidable obstacle to the broad issuance and acceptance of these instruments....

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The euro area's debt hangover

The ongoing difficulties in Greece – combined with the ECB’s dramatic actions to ward off deflation – are distracting attention from what may be the euro area’s biggest and most pervasive problem: debt.

You wouldn’t know it from the record low level of government bond yields, but much of Europe lives under a severe debt burden. Nonfinancial corporate debt exceeds 100 percent of GDP in Belgium, Finland, France, Ireland, Luxembourg, Netherlands, Portugal, and Spain. And, gross government debt (as measured by Eurostat) is close to or exceeds this threshold in Belgium, France, Greece, Ireland, Italy, Portugal and Spain...

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